A limited company is a distinct legal entity, separate from its owners, that provides limited liability protection to its shareholders. This means that the personal assets of the shareholders are protected in the event of the company’s financial failure, and their liability is limited to the amount they have invested in the company. Limited companies are a popular structure for businesses due to their ability to raise capital, attract investors, and provide credibility. They can be either privately owned or publicly traded.
1. Types of Limited Companies
There are two primary types of limited companies, each with specific characteristics and legal requirements:
A. Private Limited Company (Ltd)
- Ownership: Owned by private individuals or entities, with shares not available to the public.
- Share Transfer: Shares are typically restricted and can only be transferred with the consent of other shareholders.
- Management: Managed by directors appointed by the shareholders.
- Examples: Family-owned businesses, startups, and small to medium enterprises (SMEs).
B. Public Limited Company (PLC)
- Ownership: Owned by shareholders, with shares traded publicly on the stock exchange.
- Share Transfer: Shares are freely transferable and can be bought or sold by the public.
- Management: Managed by a board of directors, with stricter regulatory and reporting requirements.
- Examples: Large corporations and multinational companies.
2. Key Features of Limited Companies
A. Separate Legal Entity
- A limited company is legally separate from its owners, meaning it can enter contracts, own assets, sue, and be sued in its own name.
B. Limited Liability
- Shareholders’ personal assets are protected, and their liability is limited to the amount they invested in the company.
C. Perpetual Succession
- The company continues to exist even if ownership or management changes, ensuring business continuity.
D. Ability to Raise Capital
- Limited companies can raise capital by issuing shares or borrowing from financial institutions.
E. Regulatory Compliance
- Limited companies are subject to regulatory oversight and must comply with legal requirements, including filing annual reports and financial statements.
3. Formation of a Limited Company
Forming a limited company involves several legal and administrative steps:
A. Choose a Company Name
- The company name must be unique and comply with local regulations. It typically ends with “Ltd” for private companies or “PLC” for public companies.
B. Register the Company
- The company must be registered with the relevant government authority (e.g., Companies House in the UK). Registration includes submitting the Articles of Association and Memorandum of Association.
C. Appoint Directors and Shareholders
- A limited company must appoint at least one director and define the shareholders who will own the company.
D. Issue Shares
- The company must issue shares to its shareholders, defining their ownership stakes and voting rights.
E. Obtain Necessary Licenses and Permits
- Depending on the nature of the business, the company may need specific licenses or permits to operate legally.
4. Advantages of Limited Companies
A. Limited Liability Protection
- Shareholders are only liable for the amount they invested in the company, protecting their personal assets from business debts.
B. Enhanced Credibility
- Operating as a limited company can enhance the business’s credibility with customers, suppliers, and investors.
C. Tax Efficiency
- Limited companies may benefit from tax advantages, such as lower corporate tax rates and the ability to deduct certain business expenses.
D. Ability to Raise Capital
- Limited companies can raise funds by issuing shares or attracting investors, making it easier to finance growth and expansion.
E. Continuity and Succession Planning
- The company continues to exist independently of its owners, allowing for smooth succession and long-term planning.
5. Disadvantages of Limited Companies
A. Regulatory and Compliance Requirements
- Limited companies are subject to strict legal and regulatory requirements, including annual reporting and audits.
B. Public Disclosure
- Financial statements and other company information must be publicly disclosed, reducing privacy for the business owners.
C. Complex Setup and Administration
- Forming and managing a limited company involves more administrative work and legal complexities compared to sole proprietorships or partnerships.
D. Profit Distribution Restrictions
- Profits are distributed to shareholders as dividends, which are subject to taxation, and must be declared according to legal guidelines.
6. Accounting for Limited Companies
Accounting for limited companies involves maintaining accurate financial records, preparing financial statements, and ensuring compliance with tax and regulatory requirements.
A. Financial Statements
- Balance Sheet: Shows the company’s assets, liabilities, and shareholders’ equity at a specific point in time.
- Income Statement: Reflects the company’s revenues, expenses, and profits over a period.
- Cash Flow Statement: Tracks the flow of cash in and out of the business, highlighting operational, investing, and financing activities.
B. Share Capital and Dividends
- The company must record the issuance of shares, changes in share capital, and the payment of dividends to shareholders.
C. Corporate Taxation
- Limited companies are subject to corporate tax on their profits. Accurate tax reporting and compliance with tax laws are essential to avoid penalties.
7. Example of a Limited Company
ABC Ltd is a private limited company with three shareholders: Alice, Bob, and Carol. The company issues 1,000 shares, with each shareholder holding an equal number of shares. ABC Ltd earns a net profit of $150,000 in the financial year.
A. Share Capital and Dividend Distribution
The company decides to distribute $90,000 as dividends, with each shareholder receiving an equal share.
Journal Entry for Dividend Distribution:
- Debit: Retained Earnings $90,000
- Credit: Dividend Payable $90,000
Dividend Payment to Each Shareholder:
- Debit: Dividend Payable $30,000
- Credit: Bank Account $30,000
Understanding Limited Companies
Limited companies offer numerous advantages, including limited liability protection, the ability to raise capital, and enhanced credibility. However, they also come with increased regulatory requirements and administrative complexities. Understanding the legal, financial, and operational aspects of limited companies is essential for business owners, investors, and stakeholders to make informed decisions and ensure the long-term success of the business.