What are limited companies?
Limited companies are incorporated business organisations with a distinct legal personality, limited liability and unending existence. These characteristics make ownership of a company more attractive than ownership of a sole trader or partnership.
Distinct legal personality
A company is a different entity from those who form it. In other words, the company has a distinct legal personality, or it is regarded as an artificial person legally. Therefore, a company can sue and be sued in its own name. This is why many people prefer to invest in a limited company; they do not risk losing their personal assets if the business is unable to settle its debts. A sole trader, on the other hand, is not different from the owner. If the business is sued, it is the owner that will be dragged to court.
This does not give the owners the freedom to engage in fraudulent activities. The shareholders or directors can be held liable if they use the company to engage in unlawful activities.
Limited liability
The owners of a limited company will not be personally liable for the debts of the company. If the company is insolvent, the maximum amount that an owner or member can lose is limited to the capital invested in the business for a company limited by shares or the amount he has guaranteed to provide for a company limited by guarantee.
Unending existence
A company is expected to operate in perpetuity. It is assumed that it will not stop operating in the foreseeable future. Therefore, the company continues after the death or retirement of the shareholders or owners. New people can buy the company’s shares, and shares can also be transferred to the next of kin of a deceased shareholder. For sole traders and partnerships, there is no guarantee the business will outlive the owners. In fact, the death of a partner usually brings a partnership business to an end.
Types of limited companies
The two types of limited company are:
1. Company limited by shares
2. Company limited by guarantee
Company limited by shares
A company limited by shares is owned by shareholders, i.e. individuals who pay for the shares of the company. A share is a unit of capital of a company. The amount a shareholder can lose if the business runs into trouble is limited to the maximum invested in the company’s shares. No shareholder will be personally responsible for the debts of the company by using his assets to offset the company’s debts. It is, however, possible for a company to have one shareholder whose liability is limited. The shareholders receive part of the profit of the business known as a dividend as compensation for their investment in the business.
Company limited by guarantee
Here, there are members who have undertaken to pay an agreed amount if the business is unable to settle its creditors. These members’ personal property cannot be used to settle the company’s debts. The maximum they can lose is the amount they have agreed to pay if there is a problem. The members of this business are not allowed to withdraw part of the profit. The profit is usually held in the business or used for other purposes the business has predetermined. This kind of company includes non-profit companies like charities and non-governmental organisations.
Types of company limited by shares
Private limited company
The shares of a private limited company are not available to the general public through the stock exchange. They can only be sold to family and friends. If any shareholder wants to sell his stake, the other shareholders must be in the know and agree to it. It also enjoys some privacy in that it is not required to publish its accounts. However, the accounts must be submitted to an agency responsible for registering companies, e.g., the Companies House in the UK, and the Corporate Affairs Commission in Nigeria. The word “Limited” is usually added to its name. It is “Pte’ in some jurisdictions.
As a limited company, it still retains the features of separate legal existence, limited liability, and perpetual existence. Also, it must submit some documents for it to be incorporated and receive a certificate of incorporation. Also, the company is required to ensure it keeps proper accounting records. Normally, a company is subject to double taxation, in which the company pays tax on its profits and shareholders pay taxes on the income received from the company.
Public limited company
Many big businesses choose this type of structure because it is allowed to raise finance by selling its shares to the members of the public. It can sell its shares through the stock exchange, which improves its access to funds and provides an avenue for existing shareholders to sell their stake in the company. The risk in this is that existing shareholders may lose control as any individual or entity can buy the shares on the stock exchange. “Plc” or “Incorporated” is usually added to the company’s name.
Memorandum of Association
This is one of two major documents required for a company to be incorporated. A memorandum of Association must include the name of the company, its location, share capital and its purpose. This document outlines information that are useful to outsiders.
The name of this document is actually determined by the country of operation. In the US, it is referred to as Articles of Incorporation or Certificate of Organisation..
Articles of Association
This document spells out the information required for the management of the business. It states the responsibilities of the directors, how shareholders meeting will be held, how the accounts will be audited, rights of shareholders, etc. The equivalent in USA is the Corporate Bylaws or Operating Agreement, depending on the company type.
Advantages and disadvantages of a private limited company
Advantages of a private limited company
Shareholders have limited liability
Shareholders cannot lose beyond the capital invested in the shares of the company. if the business fails. Shareholders love this because their private assets are protected. This is not the case with unincorporated entities like sole traders and partnerships
More capital
It has more capital than a sole trader or partnership as it can sell shares to friends and family to raise extra finance.
Continuity
The business does not cease business operations at the death of the owners. The business is separate from the owners, and shares can be transferred to other persons who can continue running it.
The accounts are not published
Unlike public limited companies, private limited companies are not mandated to publish their accounts in the newspapers. They are only required to submit to the organisation that is in charge of registering companies in a country.
Separate legal existence
The company is a distinct entity from the shareholders. This means that the shareholders are not the ones sued if the company is dragged to court. Therefore, no time is wasted or cost incurred by the shareholder in any litigation involving the company.
Shareholders retain control
The shares of a private limited company are not publicly available. As a result, the original shareholders cannot lose control to those who could acquire controlling interest by buying its shares on the stock exchange.
Disadvantages of a private limited company
Not easy to sell shares
Unlike a public limited company, the shareholders cannot easily dispose of their shares if they wish because the shares are not actively traded on the stock exchange.
Privacy is limited
There is no complete secrecy in handling the accounts, as the company still has to submit its accounts to the Registrar of Companies. The accounts can be accessed from the Registrar’s office even though they are not published in newspapers across the country.
Limited finance
The company is not allowed to raise additional capital from the general public by issuing shares on the stock exchange compared with a public limited company. Therefore, the capital available for expansion is limited because only family members and friends can take up additional shares in the company.
Relatively difficult to establish
Compared to a sole trader or partnership, a private limited company is difficult to establish. Proper documentation with the agency responsible for incorporation is required before it can commence operations.
Creditors or suppliers may be discouraged
A private limited company is small compared to a public limited company as it is owned by family members and friends. The small size, coupled with the limited liability feature, discourages suppliers and creditors because the company is deemed risky. There is nobody to hold responsible if the business finds it difficult to pay its debts.
Advantages and disadvantages of a public limited company
Advantages of a public limited company
More finance
A public limited company can quote its shares on the stock exchange. It can raise substantial capital by issuing and selling shares to members of the public. In addition, it is easier to raise finance with better terms because of its large size and the perception of being less risky.
Listing enhances its reputation
Quoted companies usually have better reputation among suppliers, customers and investors. This is because listed companies adhere to stricter regulations and are less likely to default.
Limited liability
The shareholders cannot be held liable for unpaid loans if the company becomes insolvent. The only thing they stand to lose is the capital contributed to the business.
Continuity
The demise or retirement of the shareholders cannot bring the company to an end. Shares can be inherited by children or other beneficiaries of the shareholders. Also, shares can be bought by new investors.
Separate legal existence
A public limited company is separate from its owners and has the rights of an artificial person to take legal action against any individual or business. Legal action can also be taken against the company without involving the shareholders.
Disadvantages of a public company
No privacy
There is no secrecy in handling the accounts of a public company because the accounts are required to be published for scrutiny by any member of the public.
Not easy to establish
The formalities required to bring the company into existence are more stringent than for a sole trader or partnership. This also makes it more expensive to establish because professionals may be employed to handle registration and subsequent compliance such as filing annual returns.
Loss of control
Because its shares are available on the stock exchange, most of its shares can be bought by an outsider. This will lead to loss of control by the original shareholders.
Listing on the stock exchange is costly
Listing on the stock exchange for the first time requires paying a listing fee and hiring a lot of consultants, e.g. accountants, auditors, legal advisers and underwriters.
Price volatility can harm the business reputation
If there is a temporary dip in financial performance, the company’s share price may be depressed and investors may not want to continue investing in the company. It is possible for a company to be sacrificing short-term gains for long-term value creation. However, the company must continue to make short-term profits and pay dividends in order to be rewarded with high share price.
Ownership is divorced from from control
A public limited company is owned by shareholders but managed by the managers. These managers, who are expected to act in the interest of the shareholders, do take decisions that do not maximise the wealth of the owners. For example, the managers may be interested in increasing market share instead of maximising profit for the shareholders.