This article provides an overview of what is a company, the different types of companies available, and why you may want to think about using a company structure for various purposes.

This article is not financial or legal advice, just a short overview with a minor sprinkling of history.

WHAT IS A COMPANY?

Starting with the basics, a company is a unique legal entity with certain rights and obligations. Companies can do many things that humans can do. Equally, they face many of the same penalties that humans do as well.

Companies can buy and sell things, raise money, make money, pay taxes, and make donations. A company can be found guilty of criminal charges including murder. Typically, a company can’t be held responsible for the actions of others, the same as a human.

The legal definition of a company and what it can do will vary by jurisdiction, sometimes within states / territories of the same country. Therefore, as a company is a legal construct (there are no companies naturally occurring in nature), the State has some reserve control over what a company can and can’t do.

WHAT ARE THE DIFFERENT TYPES OF COMPANY?

This article focuses on types of companies that exist for financial gain, and not charities, NGO, quangos, State entities, etc. Similarly, we won’t cover sole proprietorship (“one man band”) and partnership structures. The exact names of different types of companies can vary by jurisdiction.

Throughout, the term “limited” is often used, and this refers to how much exposure i.e. how much the owner(s) stand to lose.

Public limited company

A public limited company is listed on at least one stock exchange, enabling shares of this company to be purchased by the public. The extent of liability is limited by shares i.e. a shareholder is only limited in liability based on shares owned, that’s all that the shareholder can lose. If the company is declared bankrupt then the shareholders stand to lose all of the money that they invested (the purchase of shares), and nothing more.

The financial performance of the company is a matter of public record, usually dictated as per the terms of the stock exchange(s) that the company is listed on.

Private limited company

Similar to a public limited company, the limit of liability for a shareholder is the amount that they have invested. Unlike a public company, ownership of a private company is limited to those invited to purchase shares. The nature and extent of public (or even governmental) financial disclosures of a private company varies by jurisdiction.

A private limited company can also be limited by guarantee. This means that there is a fix cap on the amount of money that the company could lose in the event of litigation.

Royal Charter

This is a little more archaic, and relates to powers granted by a sovereign. In the United Kingdom, this includes companies such as the British Broadcasting Corporation (BBC) and the Bank of England (BoE). In the past, this also covered the British East India trading company.

HOW IS A COMPANY FORMED?

There are three ways that a company is usually formed, although the intricacies will vary by jurisdiction. The options below are listed in descending order of frequency of occurrence.

Incorporation

This is by far the most common method, including for public companies. It requires submission of paperwork to a government registrar / body. There may also be a requirement to provide evidence of share capital as part of the formation process.

For the United Kingdom, check out the Government website for step-by step instructions.

Act of Parliament

This method is used from time to time, particularly for non-profit organisations such as hospitals and universities.

Act of Sovereign

This form of incorporation isn’t used much anymore, particularly in the West. The company is created by decree of a King / Queen, and comes into existence based on a Royal Charter (described above).

WHAT ARE THE BENEFITS OF A COMPANY?

If you’re starting out in business, you you’ll typically begin as a sole trader. You don’t necessarily need to do anything specific to start selling goods or services, and any profit that you make is part of your personal taxable income. The benefits of a company as opposed to acting as a sole trader (proprietor) include:

Separate legal identity

You are not your company, as your company is a different legal entity to you. This means that the responsibilities of your company, or a company that you have some ownership stake in, are separate to your personal responsibilities. If the company is declared bankrupt, or is subject to crippling litigation, then you personally aren’t liable for the debts of the company (in the majority of circumstances).

All you stand to lose is the amount of money that you have invested in the company.In the event of bankruptcy, this can include both your share capital as well as any Director loans that you may have made to the company.

Taxes

Building on the previous point, the fact that the company is a separate entity to you (the owner), it pays taxes separately to you. This means that your personal income tax is separate to that of your company. The significant exception to this relates to company dividend payments, which may be subject to personal income tax upon receipt.

The tax rate companies is typically quite different to individuals. In countries where personal tax rates change at different thresholds, company taxes typically stay at a flat rate. In addition to all of this, the set of allowable deductions and tax treatment of profits across years is different for companies. There are typically many incentives to be incorporated from a financial standpoint, compared with trading as an individual.

Perceived credibility / legitimacy

In terms of the work that you and your business does, there is unlikely to be a difference in output than if you were incorporated (ignoring regulated industries, for instance). However, the perception that a company is a large and well established business creates a sense of “credibility” or “legitimacy” in the eyes of some people.

This could mean that customers may choose you because a company looks more “official” than somebody running a backyard operation. Even if your company is run in your backyard!

WHAT ARE THE DOWNSIDES OF INCORPORATING?

So far, the case for incorporation looks pretty compelling, right? There are downsides, and depending on what you’re doing and where you are trading, they could be significant.

Costs of incorporation and administration

Setting up a company costs money, time (which has its own cost), and potentially resources. Once a company is a legal entity, there are ongoing reporting requirements so long as the company remains open (even if dormant). There is likely to be ongoing accounting fees for filing tax returns and financial statements.

In some industries, companies will come with additional burdens related to insurance and memberships in order to trade. Lastly, in the event of a sale or wind down, there will be costs to shut up the company.

Privacy / disclosure requirements

Many jurisdictions have expectations of companies to submit periodic financial reports, varying in frequency and level of detail. This is often in addition to any taxation reporting requirements, which are likely to be in place for any location that a company conducts business in.

In the United Kingdom, for example, the list of owners, directors, and the basic financial statements for every private company (as well as public company) is a matter of public record. Other countries are much less onerous with reporting requirements, and often information is not available to the public. This can mean that there is no need for a company to disclose the list of shareholders, financial performance, or other information.

Companies can’t move jurisdictions

Humans have the ability to get on a plane, train, boat, etc and move to a new country and do business. This means that the human can change where they pay tax, including moving to somewhere that has a much more favourable tax treatment for them. If the person continues to run as a sole trader, their business income is likely to also be subject to this new favourable treatment.

On the other hand, a company is firmly rooted in the place that it was created. A company (as a legal entity) never moves, rather a new company is created, the assets moved across, and the old entity is usually shut down. Depending on what the company is being used for, this may not be an issue.

WHAT HAPPENS IF I DON’T INCORPORATE?

As far as what happens if you don’t incorporate, this (like everything else said above) depends on what your business is doing. If the business starts to experience any modicum of success, or starts selling goods or services in environments that tend to be litigious, incorporation is definitely worth exploring.

CONCLUSION

In this short article, the summary purposes as well as advantages / disadvantages of a company have been covered. For many businesses, the path to incorporation is preferable, or inevitable.

The good news is that you can usually take a little time to decide. In any case, make sure that you reach out to a qualified accountant or lawyer in the jurisdiction that you are interested in to learn more.