Incorporation: Advantages of Forming a Limited Company
- GCSE, AS, A-Level
- AQA, Edexcel, OCR, IB
Last updated 22 Mar 2021
Whilst many businesses prefer to trade as a sole trader or a partnership, nearly all significant businesses operate as an incorporated company. The main advantages of incorporation via a limited company are summarised below:
Separate Legal Identity
A limited company has a legal existence separate from management and its members (the shareholders)
Members' liability is limited ("limited liability")
The protection given by limited liability is perhaps the most important advantage of incorporation. The members' only liability is for the amount unpaid on their shares. Since most private companies issue shares as "fully paid", if things go wrong, a members' only loss is the value of the shares and any loans made to the company. Personal assets are not put at risk. The protection of limited liability does not, however, apply to fraud. Company directors have a legal duty not to incur liabilities in their companies which they have reason to believe the company may not be able to pay. If creditors lose money through director fraud, the directors' personal liability is without limit.
Protection of Company Name
The choice of company names is restricted and, providing a chosen name complies with the rules, no-one else can use it. The only protection for sole traders and partnerships is trademark legislation.
Once formed, a company has everlasting life. Directors, management and employees act as agent of the company. If they leave, retire, die - the company remains in existence. A company can only be terminated by winding up, liquidation or other order of the courts or Registrar of Companies.
New Shareholders and Investors can be easily introduced
The issue, transfer or sale of shares is a relatively straightforward process - although existing shareholders are protected via their "preemption" rights and by company legislation that seeks to protect the interests of minority investors.
The process of lending to a company is also easier than with other business forms. The lending bank may be able to secure its loan against certain assets of the business (a "floating charge") or against the business as a whole ("fixed charge".
Better Pension Schemes
Approved company pension schemes usually provide better benefits than those paid under contracts to self-employed sole trading businesses.
Sole traders and partnerships pay income tax. Companies pay Corporation tax on their taxable profits. There is a wider range of allowances and tax-deductible costs that can be offset against a company's profits. In addition, the current level of Corporation Tax is lower than income tax rates.