Should You Be Limited? A New Entrepreneur’s Guide to Risk and Limited Liability Companies

01 JUL 2012

As a new business owner it is important not to encumber yourself or your business with too many trappings of larger enterprises. If you decide your business needs a new office, a receptionist, ten employees and matching computer systems before you open your doors you are almost certain to fail. All those things are “fixed costs” and if you don’t have incoming revenue you’ve got no business incurring them.

Tip: If you are thinking of starting a new business, you might want to join our Meetup. Its free and we have some events coming up when you’ll get to hear Doug Richard speak live, share refreshments and meet other new business owners in the UK.  If you are a Creative Professional thinking of starting a new business visit www.schoolforcreativestartups.com.

Setting up a Limited company is also a fixed cost. Once you create one you’ve got to meet obligations to UK taxing authorities and you’re bound to adhere to a certain set of rules if you want the protection that being a limited liability company provides.

Is being a limited company worth the hassle and cost? Or is it something your business can forego for a few months until you have revenues to make the investment worthwhile…

What is a Limited Liability Company?

Becoming a Limited company means that your losses in the company are limited to what the company owns. If, for example, you invest £500 in the business and it gets sued by a customer right away, you lose £500. If you grow the business over time, and it buys apartment buildings or creates software, someone who sues the company may be able to take those things away.

However, if you have obeyed the rules associated with running a limited company, your personal assets (which you may have purchased through a generous salary paid by the limited company you own) will almost certainly be protected.

A limited company is a “fictional person” that must pay for it’s own mistakes.

If you run your business as a sole proprietorship rather than as a limited company, you are your business. So any mistake you, your employees or contractors make operating the enterprise can result in you being sued and your personal assets being lost.

I think it is now clear why someone who runs large rock concerts, creates construction equipment, builds buildings needs the protection of a limited company. They need to limit their liability.

If you have multiple partners running a business that is not a Limited company, all of their assets are on the line for the mistakes their business makes.

There is a way to limit liability to partners in an enterprise (a limited liability partnership) but generally speaking entrepreneurs starting a business decide they are either going to be sole proprietors with unlimited liability or limited liability companies instead.

Limited Liabilities and Investment

Investors who put money into a business want the enterprise to be a Limited company because they want to have at risk ONLY the money they’ve put into the enterprise. If someone gives you £50,000 they usually want to own a percentage of your limited liability company so that the most they can lose is £50,000.

Limited companies come in two varieties. A company can be limited by shares (CLS) or by guarantee (CLG).

A CLS company’s owners own shares in the company and each share has a £ price. The number of shares owned by any given investor usually determines how much control they have over the company. So you may start your business as a CLS owning 100% of the shares and over time, as you grow revenue, you may take on partners who buy shares of your stock. As long as you own more than 50% of the stock, you are in control of your company.

A CLG company gives everyone who owns the business an equal share. So six “guarantors” in a CLG all have equal voting rights and a majority rules on every decision. This is a frequently chosen setup for a social enterprise where the owners don’t want wealth and share ownership to determine the course of the business.

When does a Limited Liability Company fail to provide protection?

It is possible to “pierce the the veil of protection” offered by a limited company by failing to meet your obligations as a director. If you engage in criminal activity or fraud with your enterprise this will also pierce the veil of protection offered by a CLS or CLG. If you treat your limited company’s bank account as a personal bank account (buying objects not for business use, etc) then the courts may rule that you were never a limited company at all. If you fail to use your limited company to conduct business, you may also find that you don’t receive its protections. For example, if you buy a business insurance policy to cover a structure you own personally you may find the insurance company doesn’t have to pay when the building burns down because the structure was never owned by the business.

So, Should You Be Limited?

Generally legal experts recommend that you create a limited company when you are engaging in activities that are in anyway likely to expose you to the risk of being sued, when you plan to take outside investment, or when you have partners.

Now, it is always important to understand that anyone can be sued at anytime. Someone can sue you for parking your circus on their castle lawn even when you don’t have a circus and they don’t have a castle. You will still need to mount a legal defense to explain that they are out of their minds to the court.

This kind of law suit doesn’t happen much because officers of the court are supposed to stop frivolous lawsuits at the source, but frivolous is in the eye of the beholder.

As a business owner, if you sell original paintings, tailor wedding dresses or make bead jewelry, you are unlikely to be the target of an expensive law suit. Your paintings are unlikely to be forgeries that violate someone’s copyrights. Your dresses just need to be ready on time and your beads aren’t likely to kill anyone. If you are running those kinds of limited risk companies you may not need to create a limited company right away.

If you run an enterprise which does anything that might cost someone a lot of money or involves anything that people value greatly (houses, family members, pets, their own businesses) you probably do need to be a limited company to operate without putting your assets (now or in the future) at risk.

Of course you should chat with a solicitor…

If you are the least bit uncertain about the liability that you may face in running your business, or if you need help setting up your enterprise and running it correctly, contact a solicitor who can help you. Having read this article you’ll be in a good position to understand the questions they ask you and the advice they give you.

There are many thousands who provide this consultation for free to potential customers, and others who make the service available at a very affordable charge.

The most risky thing you, as a business owner, can do is to go without the protection of a limited liability company and then go on to develop a successful enterprise. Sooner or later you, an employee or contractor will make a mistake and you will lose everything you have worked so hard for.

 

ARCHIVE