You have quite likely heard the term “limited liability”, even if you may not fully understand its legal, business and financial implications. In practice, limited liability is much more than a legal safeguard: It ensures business investment, innovation and even business continuity, all of which are essential for economic growth in the UK. In this article we will look at everything that you need to know about limited liability, including what it means, its significance in UK business formation and the differences between limited and unlimited liability. We will look also at the legal implications of limited liability, its advantages and disadvantages and how to establish a limited liability company for your business.
Understanding the Concept of Limited Liability
Limited liability keeps the personal assets of business owners and the financial obligations of the company completely separate from one another. A limited liability business is a legal “person” in its own right that is separate from its shareholders. Limited liability minimises the personal financial risk of business owners and shareholders. If a limited liability business fails then its investors and owners are safeguarded and will not be exposed to the losses of the business. This means that the company’s creditors cannot take their private or personal assets, including property, money, investments and vehicles. If a limited liability company fails or is sued then the maximum financial exposure of shareholders and owners is limited to their investment in the company.
It is important to note, however, that although limited liability provides a great deal of legal and financial protection, it does not guarantee absolute immunity. By negligence, wrongful or fraudulent trading, or engagement in criminal activities, owners of limited liability companies may still expose themselves to personal liability and, potentially, to criminal prosecution.
The Importance of Limited Liability in Business
It is fair to say that, without limited liability, our economy would be considerably smaller and less diverse. Limited liability provides peace of mind to investors that they will not lose their personal assets if the business runs into trouble.
Limited liability provides an incentive for entrepreneurship and investment in projects across a wide range of industries. This is because entrepreneurs are more likely to embark on ambitious projects and explore new areas of business when they are shielded from personal loss.
How Limited Liability Protects Your Personal Assets
From the moment that a limited liability entity is incorporated by Companies House its members are protected by limited liability. Under a limited liability structure the financial obligations of the business, including its debts and legal liabilities, are strictly limited to the assets of that business. Any personal assets owned by its shareholders – including homes, cars, money and investments – are all shielded from the reach of the company’s creditors.
In companies limited by shares, shareholders are liable only for the payment of their shares. Once the shares are fully paid-up the shareholder is no longer personally liable and their personal assets are fully protected. It is important to bear in mind, however, that some companies allow shares to be paid partially or to remain unpaid. In these circumstances, there may be some remaining personal liability.
The Role of Limited Liability in UK Company Formation
Limited liability companies in the UK are required to register with Companies House. This registration process involves providing key details about the company, such as its registered office, directors and the nature of its business activities (see below for more details on the incorporation process).
Before applying to register a company, either directly through Companies House or with the valuable knowledge and help of a company formation agent such as Uniwide Formations, it is important to consider the type of business structure that will best suit your needs. There are several types of business that can be registered at Companies House, including:
- Private limited company by shares (Limited / Ltd.).
- Private limited company by guarantee (Limited / Ltd.).
- Public limited company (PLC).
- Private unlimited company.
- Limited liability partnership (LLP).
If you form a limited liability company in the UK then the business becomes a legal entity which is separate from its owners.
Differences Between Limited Liability and Unlimited Liability
The main differences between limited liability and unlimited liability businesses concern the level of personal risk exposure faced by business owners. With an unlimited liability business, there is no legal separation between the business and its owners. The personal assets of unlimited liability business owners are not protected and can be used to satisfy the debts and liabilities of the business. Limited liability businesses, however, are legally distinct from their owners who are therefore protected and not exposed to the liabilities of the business.
The Legal Implications of Limited Liability
From a legal standpoint, a legal liability business is a body corporate that is completely separate from its members and can do anything that a legal person can do. This means that it can enter into contracts, acquire assets and incur liabilities in its own name.
In some circumstances, a shareholding member of a limited liability business may be required to contribute to assets of the business if – for example – they:
- Are found guilty of misfeasance – i.e. they fail to discharge their legal duties as a director or partner;
- Fall within special clawback provisions under the Insolvency Act 1986 or:
- Are required to contribute by agreement between the members.
Advantages and Disadvantages of Limited Liability
- The separation of personal and business assets protects the personal wealth of business members (i.e. shareholders and owners).
- Limited liability businesses are widely viewed as attractive to investors because they limit their personal financial exposure.
- The death or withdrawal of a shareholder does not necessarily affect the continuity of the business.
- Setting-up and maintaining a limited liability structure can be more complicated and expensive than other business types.
- Limited liability companies may need to comply with more regulations, reporting requirements (e.g. to HMRC and Companies House) and corporate formalities.
- Shareholders may have limited control over certain business decisions, depending upon the structure.
How to Establish Limited Liability for Your Business
Establishing limited liability for a business typically involves several steps, as follows:
- Choose a legal structure that offers limited liability and is suitable for your needs, such as a private limited company by shares (Limited or Ltd) or a private limited company by guarantee (Limited / Ltd).
- Understand your legal obligations for the type of legal structure that you choose (e.g. reporting requirements).
- Choose a suitable company name that has not already been used.
- Choose your directors and company secretary.
- Decide on your company’s registered address (a formation specialist, such as Uniwide Formations, can provide you with a registered address if this is needed).
- Determine your shareholders or guarantors.
- Identify any persons with significant control (PSCs).
- Register your limited liability business with Companies House. This process can be completed online either directly with Companies House or through a company formation specialist (such as Uniwide Formations). You will need to provide at least 3 pieces of personal information about yourself and any other shareholders, including town of birth, mother’s maiden name, father’s first name, telephone number, national insurance number and/or passport number. You will need also to pay a company registration fee.
Case Study: The Impact of Limited Liability on Businesses
One notable example of the effect of limited liability upon business is the online fashion retailer ASOS. The company was founded in 2000 and quickly expanded worldwide. The limited liability structure of the company meant that it could attract huge investment without exposing the personal assets of its founders. The separation of personal and business liabilities shielded the entrepreneurs from substantial financial risk as they navigated the challenges of the competitive fashion industry. Since 2000 ASOS has transformed into a leading e-commerce platform that proves just how greatly limited liability encourages entrepreneurship and facilitates business growth in the UK.
Frequently Asked Questions about Limited Liability
Is limited liability only for large corporations?
By no means is limited liability exclusive to large corporations. Businesses of any size – startup, small, medium or large – can all benefit from limited liability by structuring themselves as a limited company (Limited / Ltd). or another limited liability business type.
Can personal assets be at risk despite limited liability?
Although limited liability protects personal assets in most cases, shareholders in a company can still expose themselves to personal financial risk – and also to criminal prosecution – should they engage in illegal or fraudulent activities.
Are there alternatives to limited liability?
An alternative to limited liability is unlimited liability, whereby personal assets are not protected; for example by doing business as a sole trader or in a general partnership. On the other hand, unlimited liability business owners often have fewer legal obligations and filing requirements to meet.
Limited liability is key to entrepreneurship, investment and economic growth in the UK. It not only shields personal assets from business liabilities but also encourages innovation and risk-taking, both of which are vital for economic growth. Although limited liability provides a legal safeguard, thereby allowing businesses to thrive, it also places responsibilities on members to adhere to strict reporting and legal requirements. If you are considering setting up a new limited company in the UK in 2024 or beyond then it is important to weigh up the options available to you. Remember: One size does not fit all when it comes to business structures. Your decision will depend on the size of your business, your future plans for growth and how you plan to encourage investment. By choosing a business structure that is suitable for your needs you can maximise your potential for success.