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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.
What is Incorporation?
A company is incorporated if it can own its own assets and enter into its own contracts. Only incorporated entities have these rights. Therefore, incorporation is a legal process that takes an unincorporated business and transforms it into its own legal personality.
However, incorporation does not happen automatically. Unless you go through specific legal steps, 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). This requires you to be in a business venture with at least one other person with a common view to sharing in the business’ profits.
Are There Different Kinds of Incorporated Business?
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.
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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.
However, 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 will not be responsible for the debts of their company beyond a certain amount.
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’ debts.
The Limit of Your Liability
In legal terms, 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.
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.
The exception is if the company’s owners defraud others. In this case, the principle will not apply.
Other Benefits
The other main benefit to 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, like 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’ annual accounts.
There are other duties on those who run an incorporated business. These include owing a fiduciary duty to the business.
In general, if your small business can owe 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. This means that if the business cannot pay its debts, except for where there is no fraud or unlawful activity, the owners will not have to pay into the company any more than their initial investment.
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Frequently Asked Questions
An incorporated business is any business that is its own separate legal entity. That means it can own property, owe money, sue others, and be sued, and it is distinct from its owners.
A private company limited by shares is the most popular incorporated business. Like all other incorporated businesses, it can own property and enter into contracts. Furthermore, the concept of limited liability means that its owners are not responsible for the company’s debts beyond a certain amount. In most cases, this is the value they paid for their shares.
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