Advantages and Disadvantages of Incorporation

When starting a small business, there are a number of key considerations that should be addressed at an early stage. Primary amongst these is the legal status of the business. When moving away from employment, the majority of individuals initially become sole traders.

This makes very little difference to your legal or tax status; the business is you and you are the business. However, many individuals prefer to incorporate their business, and thus become a limited company. Incorporation presents a number of advantages, particularly for the individual establishing the company. However, there are also significant drawbacks associated with incorporation that should be taken into consideration.

Advantages

One of the major advantages of incorporation is the legal separation of owners and company. When a limited company is formed it becomes a legal entity in its own right, in contrast to the situation in which a sole trader finds themselves.

The owner, whose name appears on the documents of incorporation, becomes a shareholder in the company. In the past there was a necessity for a company to have more than one shareholder; this has now changed, and the owner can be the sole shareholder. Indeed, in the case of a small business, the sole shareholder may well also be the sole director.

Perhaps the most attractive feature of incorporation, as offered by current company law, is the disassociation of corporate liabilities from the directors. As the company is a separate legal entity, its directors have no legal responsibility for its debts. As such, a director cannot be bankrupted by their company’s debts, even if the company basically consists solely of that individual.

Disadvantages

In exchange, as it were, for the benefits of incorporation, there are a number of responsibilities assumed by the directors of a limited company.

In the first instance, company law dictates that limited companies must keep and file their accounts in a particular fashion. The rules regarding accounts for limited companies are stricter than those applying to individuals or sole traders; accounts must be filed, for example, with both the Inland Revenue and Companies House every year, and there are severe financial penalties for late filing. Furthermore, the accounts of a limited company are publicly available; anyone has the right to information regarding your company via Companies House.

There are also a number of tax implications associated with incorporation. In the first instance, limited companies are subject to corporation tax, as opposed to income tax. Depending on the nature of your company this could be beneficial or financially damaging. In most cases this is personally beneficial; however, if you are the sole director of the company this benefit may be mitigated.

It is well worth seeking advice from a reputable accountant on this matter, as they will be able to tell you how to get the most from your incorporation. Furthermore, as a director of a company you will almost certainly have to ‘pay yourself’ via PAYE. This can potentially mean that you end up paying more tax, as you will have to pay both employer’s and employee’s National Insurance Contributions.

As can be seen, incorporation is a major step for any company. As such, it is vital that you seek independent advice from a reputable source before making any decision.