“Corp.,” “Inc,” “LLC,” “Ltd.” – you’ve probably seen these abbreviations listed after your favorite brand names. However, if you’re interested in making your savings grow, it’s a good idea to understand what these abbreviations mean for your investments. You might already be familiar with the corporate business structure, but what business structures are available to companies that aren’t on the stock market? Meet one such option — the private limited company, aka the “Ltd.”
What is a Private Limited Company?
The private limited company is a business structure used within the UK and other member states of the Commonwealth. In fact, it is one of the most popular legal structures for small businesses within the UK. What makes this structure attractive to companies is that it offers investors what’s known as “limited liability.”
For tax purposes, the company is considered separate from its owners. Therefore, the company owns any profits (or debts!) and is responsible for paying taxes on them, not the individual owners of the company. Part of the profits can be divided up and distributed to shareholders as dividends, part can also be distributed to owners as salaries, and the rest of the profits are kept as working capital and reinvested into the business.
Unlike public limited companies, the shares of private limited companies cannot be sold to the general public on a stock exchange. Instead, shareholders looking to sell their piece of the pie must first offer their shares to other shareholders within the company.
Read also: How does the stock market work?
If no one is interested, the shares can be sold to someone outside the company only if the other shareholders approve the sale. Most companies have a limit on the number of shareholders allowed (usually 50).
If you’re confused about whether a particular company is public or private, look out for the three letters that follow the company name. In the UK, private limited companies must legally include the suffix “Ltd.” while public limited companies must use the suffix “PLC.” In the US, similar private and public business structures use the abbreviations “LLC” and “Inc.”, respectively.
What is “limited liability”?
So, private limited companies are popular for their limited liability, but what exactly does limited “liability” mean? Consider this example:
Imagine that your best friend comes up with a brilliant idea to open a taco truck business. You love tacos (who doesn’t?)! So you decide to help them get their business off the ground. You give your friend $1,000 and your friend promises you a percentage of the profits once the business is up and running. Opening day comes and people are lining up around the block to try your tacos al pastor.
However, a few weeks down the line, the taco truck has an unfortunate encounter with the BBQ truck next door, and the taco truck is totaled. Suddenly, your friend is out of business. Not only are they no longer selling tacos, but they still owe money on the truck and its renovations. Debt collectors start to come around looking for payment on the $30,000 taco loan.
Now imagine that, because you invested an initial $1,000 in the business, the debt collectors start to hold YOU accountable as a partial business owner for the remaining $30,000. You would certainly be in a sticky situation. What would you do?
Fortunately, limited liability protects shareholders in precisely this situation (even if tacos aren’t involved!). Limited liability is a form of legal protection offered to shareholders (people who invest in a company in exchange for partial ownership – “shares”) that means they cannot be held accountable for more money than they originally invested in the company.
If the company were to become insolvent and unable to pay its debts, the debt collectors can’t go after shareholders’ personal savings (you and your piggy bank in the hypothetical taco scenario) to cover the debt. Had you possessed limited liability protection, you would have only been out the original $1,000 investment.
Are there any drawbacks to private limited companies?
Although private limited companies come with a number of perks, there are some disadvantages. For example, finding investors that the existing shareholders will approve can be a challenge. Unlike public companies, shares cannot be quickly exchanged in an open marketplace, so it may take time to raise capital.
There are also more regulations than other small business structures, such as mandatory disclosure of financial accounts and other key documents that are publicly accessible.
In addition, by acting as an entity separate from the owners, managing the company’s legal and tax obligations will also be more complex, often requiring expensive lawyer and accountant fees.
The bottom line
So, what’s the bottom line for your financial goals?
If you’re thinking of investing in a business or opening one of your own, limited liability is a good way to protect your personal savings if business doesn’t go as planned. Private limited companies are one of the most popular legal structures for small businesses because they offer limited liability protection without becoming as complicated as a publicly-traded company.
If you’re in the UK, you just need to follow this simplified step-by-step process, and you could become the owner of your very own Taco Truck Ltd.
Don’t forget to check out the rest of the Academy library for other smart investing tips!