Limited Liability: What Does It Mean?

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A Limited Liability structure can be hugely beneficial to SMEs and offers protection to directors and shareholders that are heavily invested in a business. 

Find out what limited liability means, how this structure works within different company types and what this means for company directors, shareholders and partners.

What is Limited Liability?

Limited Liability is a legal structure whereby shareholders or directors are legally responsible for their company’s debts only up to the value of their shares.

The directors will only be liable for debts of a certain amount – this is up to the value of the shares they hold in the business. Incorporating as a limited company provides shareholders and directors with personal financial and legal protection from any future company insolvency issues.

In order to be structured as limited liability, a business must be incorporated at Companies House as one of the following:

• Limited Liability Company (LLC)
• Private Limited Company (Ltd)
• Public Limited Company (PLC)
• Limited Liability Partnership (LLP)

 

What is a Limited Liability company agreement?

A limited liability company has to legally obtain a set of documents in order to run. One of the most important documents is the Company Agreement that governs the general workings of a company.

It will essentially establish a set of rules that the company must follow, detailing how the business will run and solidify the relationship between multiple directors or shareholders. This agreement is a private contract between business shareholders.

 

How does Limited Liability work?

Once a company is registered as either an LLC, an Ltd, a PLC or an LLP, limited liability will be granted for the directors and shareholders.

When the company is incorporated at Companies House, it classes as separate from its directors and shareholders and therefore, the company itself is now responsible for debts and loans as opposed to the individual owners.

If the company ever reaches insolvency or is threatened with legal action by creditors, the company is again responsible rather than the individuals behind it. 

 

Forms of Limited Liability in businesses

There are a few different ways in which a business can benefit from limited liability. The main four legal structures that a company can incorporate as are:

Private Limited Company (Ltd)

A private limited company is a common business structure in the UK and is where the company owners are classed as shareholders. An Ltd company pays Corporation Tax on their profits and has to file financial reports to Companies House.

Limited Liability Company (LLC)

In an LLC, the directors and shareholders are classed as ‘members’. This model is typically adopted in the US rather than in the UK, where an Ltd is preferred. In an LLC, there can be multiple members and the company can be taxed as a partnership.

Public Liability Company (PLC)

In a public liability company, shares in the business are sold to the public via the stock market. People that buy shares are the ones classed as shareholders but are overseen by a main CEO and a board of directors. 

All the shareholders will benefit from limited liability in this scenario. 

 

Limited Liability Partnership (LLP)

A limited liability partnership is where the business has two or more owners and the business is run between them. The partners will create and sign documents that detail rules they must follow and govern things such as profit distribution, ownership percentage and debt allocations. 

The partners will pay Income Tax on their earnings but will be protected by limited liability and are classed as separate from the legal entity of the business. 

What are private companies limited by guarantee? 

A private company limited by guarantee is a separate legal entity to its shareholders like the other formats of LL, but instead the company is owned by guarantors rather than distributing shares. The company will still be run by a director or by a board, but the monetary responsibility lies with the guarantors.

The personal liability for the debts lies with guarantors, limited to a fixed nominal amount classed as the guarantee. The guarantors will have to pay company debts up until the fixed sum.

It is typically non-profit organisations, clubs and societies that are limited by guarantee. 

What are private companies limited by shares? 

In a company limited by shares, the liability will lie with the company shareholders and will be limited to the value of their shares. Essentially, the shareholders’ original investment is their guarantee.

This sub-division of limited liability is the most widely adopted and is a common structure amongst SMEs.

 

Advantages and Disadvantages of Limited Liability Companies

There are many advantages to companies utilising limited liability and very few disadvantages if you choose the right model for your business.

 

Advantages of Limited Liability

• No Personal Liability:
  Directors and Shareholders aren’t personally liable for company debts and eliminate risk of their personal assets and property being affected in the case of insolvency. 
• Tax Benefits:
  Limited companies aren’t taxed on personal tax rates. Directors can also pay themselves a salary at the personal allowance tax rate and the rest as dividends to benefit from a lower tax rate overall.  

• Future Security:
  As the company is separate from its owners, the business can continue to operate if directors should retire or step away from the business. This provides security for employees and other members.  

• Secure Company Name:
  As a limited liability company has to be registered at Companies House, the company name is protected and cannot be used by another business, thus securing it as a valuable asset.

Disadvantages of Limited Liability

• If there is any evidence of wrongdoing, business misconduct or fraudulent trading by any director or shareholder, the individual could still be held liable for subsequent debts. 
• Some directors may need a personal guarantee to secure funding, which may override the protection that limited liability would provide. This may not always be the case, but some companies will struggle to secure funding without it.

 

What to do if a limited liability company is having financial trouble 

Limited liability should not be used as a valid excuse to ignore financial troubles. Shareholders and directors of a limited liability company still have a legal obligation to protect the interests of the business in the best way that they can.

In the case of financial difficulty, you should contact a professional insolvency expert such as ourselves for advice. We can help you find the right support and put a plan in place before issues become more serious. 

 

Get in touch with us as soon as you experience financial difficulties to give yourself and the business the best chance of returning to profitability and remaining solvent.