There are many steps involved in transitioning from a business idea to a functioning business. Once you’ve created your product or service, calculated a budget and built a team, there’s still one last step before you can start trading. That’s right, it’s time to choose your legal structure.
In this article, we briefly explain the two most common legal structures for a UK business: an LTD and an LLP. We’ll also discuss the things to keep in mind when deciding between the two.
What does LTD mean?
“LTD” is generally short for “Limited”, but in the UK, “LTD” means something even more specific. When you see “LTD” or “Limited” at the end of a UK company’s name, it means that company is a “private company limited by shares”. Let’s break this down a little further.
What is a private company limited by shares?
A private company limited by shares is a company where your ownership is defined by how many you own.
The first part of the phrase, “private company”, means there’s no way for the general public to buy ownership in the company. Practically speaking, this means the company is not listed on a stock exchange (like the London Stock Exchange or the New York Stock Exchange). But, it’s important to note that LTDs can still sell pieces of ownership (i.e. shares) to people who aren’t involved in running the company.
The next part of the phrase, “limited”, means that the owners of the company have limited liability. “Limited liability” is a complex subject, but, most often, it refers to restrictions on how much money you have to pay if something bad happens.
In the context of an LTD, “limited liability” means two things. First, the company is considered an entity separate from its owners. Second, if the company incurs debt, there’s a cap on how much the owners have to pay the company’s creditors.
The last part of the phrase, “by shares”, specifies the cap on how much the owners have to pay the company’s creditors. When a company is “limited by shares”, the cap for each owner is the amount of money they paid for their shares.
Why should I use an LTD?
A private limited company limited by shares is one of the most popular ways to set up a business in the UK. There are several reasons why creating an LTD is so popular.
First, as we touched on above, an LTD minimises the owners’ personal liability. Because the company is considered a separate entity from its owners, the company can have its own responsibilities. When an LTD enters a contract, the company itself is responsible for performing its obligations.
This means that debts are the responsibility of the company rather than the individuals who run it. This acts as a shield to the owners, because if the company can’t pay its debts, the owners don’t have to pay them out of their own pockets.
Second, an LTD can be more tax-efficient than other company structures. Owners of an LTD are only taxed on money they actually receive from the company each year, rather than on their share of the profits.
Third, shares confer ownership of an LTD, but don’t automatically give much say in how the company is managed. In this sense, there can be a separation between those who “own” the company and get a piece of its profits, and those who run it on a day-to-day basis. This allows LTDs to raise money by selling shares to people who aren’t involved in management (which isn’t the case in an LLP).
What does LLP mean?
“LLP” is short for “Limited Liability Partnership”. Let’s go through what each part of that phrase means.
What is a limited liability partnership?
In the context of a UK LLP, “partnership” means two or more people have agreed to own a business together, with an equal say in how the business is run.
We’ve already talked about what “limited liability” means. As noted above, “limited liability” usually refers to a cap on how much you have to compensate someone. But, there are two main differences between limited liability in an LTD and limited liability in an LLC.
First, owners of an LLP always have an equal share of ownership in the company. This is different from an LTD, where owners’ responsibility is proportional to the shares they own. Second, owners of a UK LLP can agree in writing how much money they will be liable for, regardless of how much they “invested” at the beginning.
Why should I use an LLP?
The main benefit of using an LLP is how flexible the structure is. In an LLP, the partners have the flexibility to decide who gets what share of the profits and how much each person is liable for. (In an LTD, both of these issues are dictated by how many shares you own. If you want different owners of an LTD to get disproportional amounts of profits, it requires a more complicated structure).
LLPs are also more flexible when it comes to adding and removing owners. People can join and leave an LLP much more easily than an LTD.
Both LTD and LLP structures can be beneficial. The best choice for your business depends on your specific goals. As it so often happens in the legal world, there is no straightforward answer to which structure is best. It’s important to consider the pros and cons of each structure, including tax issues, flexibility and fundraising needs.
If you need legal guidance to help you decide which structure to use, our legal team is here to help.