What Are the Benefits of Incorporation?

If you are a business owner or are thinking of starting a business, you may be wondering what the benefits of incorporation are. For instance, you may wonder if it is worth it, since you will have many more administrative obligations. This article will explain the legal principle behind incorporation and then walk through the practical advantages and disadvantages. 

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What is Incorporation?

There is a specific process that must be followed in order to incorporate a company in the UK. Incorporation is a legal process that takes an unincorporated business and transforms it into its own separate legal personality.

Incorporation does not happen automatically. Unless you go through specific legal steps, for example, registering your business at Companies House, your business will exist as an unincorporated entity. The effect is that it will not have any separate existence from its owner. It cannot enter into its own contracts or own its own property. Therefore, all assets and any obligations, including the business’s debt, lie with the business owner.

Unincorporated Businesses 

Put another way, all businesses are unincorporated until they go through the incorporation process. 

The most common kind of unincorporated business is the sole trader (sometimes called a sole proprietorship). This legal business structure arises automatically when you engage in any commercial activity as the sole business owner. 

The other common unincorporated business is the general partnership (or unincorporated partnership). Your business will be classed as a general partnership if you run it with at least one other person with a common view to sharing in the business’s profits. 

Are There Different Kinds of Incorporated Businesses?

It is worth emphasising that there are multiple different types of incorporated businesses. 

The most common one is the “private company limited by shares”, commonly called a private company or private limited company. 

There are other kinds of incorporated businesses, including:

• public limited companies;
• limited liability partnerships; 
• private companies limited by guarantee; and
• private unlimited companies. 

Benefits of Incorporated Business Structures 

Of the four incorporated business structures listed above, aside from private companies limited by shares, the public limited companies (PLCs) and limited liability partnerships (LLPs) are the most common. This is because, along with private companies limited by shares, they all have the principle of “limited liability” in common. 

It is not generally possible to have an unincorporated business with limited liability. Likewise, the vast majority of businesses trading through incorporated structures choose those capable of benefiting from limited liability.

Limited Liability 

Limited liability refers to the fact that the company owners, such as the shareholders, will not be responsible for the debts of their company beyond a certain amount. You will enter into contracts in the name of your company rather than in your individual capacity.

The benefit of this is that you can take certain risks and, beyond the extent of your liability, will not need to take personal accountability. You will not have any personal liability greater than the value of your initial investment. This creates a “corporate veil” between your personal assets and the business’s debts.

The Limit of Your Liability 

In legal terms, in the example of a company limited by shares, your liability is limited to the amount of your fully paid-up shares in the company. This usually limits your liability to the amount you initially paid for your shares in the company. If you initially paid £100 for your shares, this would be the total financial risk you would have in the company, as if the company became unable to pay its debts, you would only lose this investment.

Exceptions to Limited Liability 

As mentioned above, there is a veil between the company and its owners. Therefore, the law will not generally permit the company’s creditors to “pierce this veil” and come after the owners in their personal capacity. 

An exception is if the company’s directors are found to be in breach of their directors’ duties, such as trading whilst insolvent. Directors, amongst other duties, can be held personally liable for wrongful trading if the company becomes insolvent and continues to trade, and the directors knew or ought to have known that there was no reasonable prospect of avoiding liquidation. Similarly, if a director knowingly engages in fraudulent activity, such as deliberately running up debts with no intention of paying them, they could be liable for fraudulent trading and can be held personally liable for the debts. 

In addition, if any shareholders have provided personal guarantees in favour of the company, then they may also be held personally liable in accordance with this personal guarantee. 

Other Benefits 

The other main benefit of incorporation is a company’s right to own its own assets. This can make it easier to enter into certain transactions because it has the full legal title over the assets. 

There are other benefits particular to certain types of incorporated companies, such as:

• the benefit of share capital (for public and private companies limited by shares); or
• partnership agreements (for LLPs).

However, these are not universal to all incorporated businesses.

Disadvantages of Incorporated Businesses

As incorporated businesses are their own legal persons, the law requires that the business be more transparent. So, practically, if you are responsible for running the business on a day-to-day basis, such as if you are the company’s director or a partner to an LLP, you will have to file more paperwork with Companies House, like the business’s annual accounts. 

There are other duties for those who run an incorporated business. These include owing a fiduciary duty to the business. 

In general, if your small business owes lots of money to another person, it is advisable to incorporate your business into a structure capable of benefiting from limited liability. 

Key Takeaways

The principle of incorporation means that a business is its own legal entity. The vast majority of incorporated businesses adopt structures that enable the owners to benefit from the legal mechanism of limited liability. 

If you need help with starting your company, our es=”true”>experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today at 0808 196 8584 or visit our membership page.

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