Insight | Sara Lilley | Director of Knightsbridge Incorporations
You have built your business. Your reputation is good, your income stream is stabilizing and you are now looking to the future. Perhaps you have been told to consider incorporation, maybe it seems the natural step. But why?
There are over 4 million incorporated companies in the UK and Gibraltar, and over 90% are actively used by people choosing the incorporation structure over a sole trader status.
Here are the top ten reasons why you should consider incorporation for your business
Protection by way of Limited Liability
- The risk versus reward question is ever present when building a business. You will be familiar with the constant weighing up of the possible risk of an action against the potential financial reward. As a sole trader, there is no protection from the consequences of a risk taken that goes wrong.
- Since 1987 however, a limited company structure however has its own legal identity, separate from those who found the company.
- When a client, a contractor, a supplier enters into a contract with the company, it’s the corporate entity that they form the contract with. Not you as a shareholder and/or director
- This legal distinction means your personal assets are ring-fenced away from the company. In a properly structured and managed business, you as a director have a limited liability for the company’s debts, i.e limited to the amount you paid for the shares and any unsecured loans you make to the company
- A well-run company will inherently have formalities for asset protection so that if the company has problems or becomes insolvent, you are not personally responsible for losses.
- However, if the company loses money due to fraud you’ve committed as a director, the creditors have the right to pursue you for their losses and you will, have an unlimited personal liability.
- A sole trader and their business are seen as the same legal entity and therefore have unlimited personal liability for business debts and in cases, can see their main residences at risk.
Credibility and Name Protection
- Generally, the addition of ‘Ltd’ or ‘LLP’ to your business name will add legitimacy and credibility to your business. It will encourage clients, consumers, contractors and vendors in their dealings with you as most prefer to do business with incorporated companies
- Furthermore, in the UK and Gibraltar, another business cannot use a trade name or form another entity that has the same name as your incorporated name, protecting it from misuse by ‘rogue traders’ and allowing you to build brand and marketing around your chosen company name.
- You are probably building a business for the long term, with the view to sale and realize your money as one of your long term goals. An incorporated company any can exist after ownership and management changes, allowing a future buyer access to the reputation of that company and the ability to compensate you financially for that ‘good-will’ and brand.
- The taxation benefits as a director of a limited company is normally the most important benefit to those who already own a company. This is because they understand the importance of flexibility. The ability to change income needs to suit lifestyle needs, changes in personal circumstances and to improve financial planning
- Corporate tax rates are generally lower than individual tax rates. Companies also qualify for additional tax benefits and deductions that aren’t available to individuals, such as capitalisation.
- A sufficient salary should be paid to ensure entitlement to State Benefits
- The company is entitled to deduct normal business expenses, including salaries, before they allocate income to owners.
- This, combined with deductible expenses, results in a higher take-home pay for all directors
- Though there is no capital gains tax payable in Gibraltar, if one of the shareholders is tax resident in other countries, such as the UK, a limited company structure offers a lot more opportunities for tax efficient exit planning. In the UK for example, a UK tax resident can benefit from Entrepreneurs relief if he/she has owned more than 5% shares for more than two years. If a sale is orchestrated to provide seed capital for a new business, it is possible to apply for capital gains tax rollover relief
- Confidence is critical in business and a limited company has a veneer of professionalism, which can instil confidence in your business.
- Some clients – large corporations and those in the financial sector especially – simply prefer to work exclusively with limited companies, but others flatly refuse to deal with unincorporated businesses. So, having a limited company can present new business opportunities that may not otherwise have existed.
- In other industries, a formal business structure is required to win certain contracts as per an internal mandate
Easier access to finance and investment
- The separate legal entity of a limited company may make it easier to secure finance than sole traders. Also, companies can raise capital by issuing new shares to shareholders and new investors – to employees, nearly anybody with the exception of the general public. Whereas a sole trader generally has to raise cash from personal assets or use that asset as collateral for finance, increasing the risk to their home and family. This is because the contracts are signed in their personal name.
- A limited company structure also allows you to establish business credit which can help you expand your business Establish Business Credit. From the date of establishment, the business itself can begin its own credit profile which might be stronger than your own.
- If a third-party investor wants to invest in your business, there is a need for an entity set-up to receive the investment. Investors, venture capitalists and business angels prefer to work with companies, since they allow for different classes of stock.
Provides a layer of privacy
- When you incorporate or form an LLC, there’s an added layer of privacy. In many cases, the registered agent of your company goes on record, and not your home or business address.
You can protect a trading name for a future business
- Let’s say you’ve had a lightbulb moment – you’ve got an inspired idea and a name for a business, but you’ve neither the time nor the capital to develop it just yet. Instead of abandoning your idea altogether, you can set up a dormant company to put the business on hold and protect its trading name at the same time.
- In the eyes of the Income Tax Office and Companies House, a dormant company is one that doesn’t trade and has made no significant accounting transactions during a financial year. Setting up a dormant company can protect your future interests.
Easier to sell/transfer business ownership
- A lot of business owners view their business as their pension, and quite often that involves selling the going concern to either another company, investor or utilising a management buy out. Sometimes, unfortunately a business owner may pass away before they get this opportunity. In any event, it’s much easier to transfer ownership of a limited company than an unincorporated structure. Clients, equipment, the whole caboodle can be amalgamated and sold off.
- For sole traders, this can be problematic, as typically the equipment used is owned by them personally, and many elements of the business are tied to their specific identity.
Ability to create Equity and Stock Options.
- A common problem when a business has more than one founder is there’s always a chance of an argument over how equity should be split – often the closer the owners are, the more difficult this becomes.
- By incorporating a company and issuing stock to founders, you can prevent misunderstandings among equity splits
- Many entrepreneurs choose to compensate third parties (i.e. employees, vendors or contractors) by granting stock options or offering the opportunity to purchase equity at a low price. This is particularly attractive at the beginning of a business when cash is tight.
A frequent question are clients ask is what peace of mind does incorporation bring? Our answer is that a company, as a separate legal entity, enjoys certain protections under law plus important benefits to its directors. Its legal business structure safeguards your personal assets and allows you to conduct your business without worrying that you might lose your home, car, or personal savings because of a business liability.
Deciding Which Business Structure is Right for You
Selecting the right type of company for your new business helps maximize your chances of financial and operational success. To get the most out of your small business, choose the right structure with an company manager or accountant. Knightsbridge Incorporations can also provide the necessary tax advice that will help you incorporate efficiently and concentrate on what you do best, developing your business for the future.
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