In the UK, private limited companies can be formed as either limited by shares or limited by guarantee. Whilst both company structures are incorporated as legal entities and provide limited liability protection to their owners, there are fundamental differences between the two. These distinctions determine their suitability for different types of businesses and organisations, so let’s take a closer look.
For profit or not for profit?
Generally, limited by shares companies are used by for-profit (commercial) businesses, whereas limited by guarantee companies are designed for not-for-profit (non-profit) organisations and charities. Essentially, it comes down to what you want to do with company profits.
If you plan to keep profits for yourself (as a source of personal income), you should set up a company limited by shares. This is the most common type of limited company. However, if you plan to reinvest profits into the business to achieve non-profit objectives, it would be best to form a company limited by guarantee.
Limited by shares companies
Limited by shares companies are owned by shareholders (members) and incorporated with share capital. This means that the company is divided into shares, each of which is assigned a nominal value (usually £1). Every member must agree to take at least one of these issued shares.
A share represents a portion of the company. In turn, the quantity and value of shares taken by each shareholder dictate:
- how much of the company they own and control
- what percentage of profits they’re entitled to receive as dividends
- the limit of their personal liability for company debts and financial losses
- the percentage of capital they can receive if the company is wound up
Limited by shares companies must be set up with a minimum of one shareholder and one share. At least one director must also be appointed to manage the company. Generally, there is no limit to the number of shareholders, shares, and directors a company can have.
It is commonplace for shareholders to appoint themselves as directors. This means that one individual can be the sole shareholder and director of their own company, or they can own and manage a company with one or more other individuals.
Why would I form a company limited by shares?
A company limited by shares is ideal for commercial businesses of all sizes and across all industries. The most common reasons for setting up a company limited by shares include:
- owning and managing a for-profit business, either by yourself or with other people
- the assurance of ‘limited liability’, which protects shareholders from being pursued by the company’s creditors or claimants
- tax efficiency – you can legitimately reduce your tax liability and enjoy better tax-planning opportunities through a limited company
- establishing an impressive corporate identity
- bidding on high-value contracts that are only open to incorporated businesses
- opportunity to sell shares in the business in exchange for capital investment
- protecting the name of your business
- greater access to business funding and investment opportunities
- claiming a wider range of tax-deductible allowances and expenses
- access to more generous pension schemes
- buying and holding assets in a company name
The range of benefits on offer makes this type of company a popular choice for freelancers and contractors, individuals who would normally operate as sole traders, SMEs, and large organisations and multinationals.
Limited by guarantee companies
Limited by guarantee companies do not have shares or shareholders. This type of company is controlled by guarantors (members) and is incorporated without share capital. Each guarantor must provide a financial ‘guarantee’ (normally £1), which is the limit of their personal liability for company debts and financial losses.
A company limited by guarantee must be set up with at least one guarantor and one director. Typically, guarantors appoint themselves as directors. This means that one individual can be the sole guarantor and director of a limited by guarantee company. Alternatively, they can own and manage the company with one or more other individuals.
In most cases, limited by guarantee companies are set up by non-profit organisations, such as:
- amateur sports clubs
- community groups and projects
- membership organisations
- trade associations
- environmental organisations and campaign groups
- community kitchens and food banks
- neighbourhood associations
- self-help groups
The purpose of non-profit organisations is to pursue specific charitable, social, environmental, or community-based objectives for the benefit of people or society, rather than generating profits for private or personal gain.
This is why most limited by guarantee companies reinvest their profits back into the business, instead of distributing surplus income to their members. However, there is no legal requirement to do this, unless the company is also registered as a charity.
Why would I form a company limited by guarantee?
A company limited by guarantee is tailored to meet the specific needs of non-profit organisations, ranging from small community-based ventures to large international charities.
The most common reasons for setting up a company limited by guarantee include:
- running a non-profit enterprise or setting up a charity, either by yourself or with other people
- providing limited liability protection to yourself and other members
- legitimising a non-profit organisation and establishing a professional image
- satisfying eligibility criteria set by the Charity Commission or other governing bodies
- accessing certain grants and other sources of funding
- attracting more support, in the way of investment, donations, or membership
- protecting the name of your non-profit organisation
It’s worth mentioning that you can use a limited by guarantee company for a commercial business. However, there is little benefit to choosing this structure over a limited by shares company, which provides greater flexibility to businesses that are set up as for-profit ventures.