forming a company

If you have decided the best trading structure for your business is to operate via a limited liability company, you have two options: either buy an existing company or set up a new one.

Here, we look at the basic steps for forming a company yourself, and explain some of the key roles and concepts involved with a limited company, such as shareholders and directors.

BASIC STEPS

1. Choose a Name

Check the publicly available register at Company House to make sure the company name you want to use is not already taken (in the UK).

If you want to use the same name or something similar as a trade mark for your products or services, first make sure no-one else has already registered the name as a trade mark (in the UK or the EU) by checking the publicly available register at the UK Intellectual Property Office.

If you want to use the same name or something similar as a domain name for your website, check whether it is available before you register the name at Company House.

2. Identify Initial Shareholders

Clarify who will own shares in your company at the beginning: just the founders, or do you maybe have investors coming on board from the start?  

How many shares will each person have on day one (rather than shares that may be 'earned' that will vest at a later date)?  Think through the percentage of shares each person will own, and the control this may or may not give them (see Shares & Shareholders below).

3. Identify Initial Directors

Clarify who will sit on the board of your company and help make day to day decisions about how it is run.  Will these people have different roles, such Chief Executive Officer (CEO, with overall lead), Chief Marketing Officer (CMO, heading up business development), Chief Technology Officer (CTO, in charge of product development)? 

 

As you grow, you may look to bring on non-executive directors as well, who may be less involved in the daily decisions but there to provide steer on more significant issues, often bringing experience from other roles or sectors where they have worked.

You may also want to think about appointing a Company Secretary to manage the company documentation and ongoing filing and  administrative duties.

4. Register at Company House

 

You need to apply to register your company at Company House, providing full names and addresses of all shareholders and directors, and indicating how many shares each shareholder will own, and how many other shares the company is to have that are not yet allocated to anyone.  

Even if you only have 2 founders who will be the initial shareholders, rather than simply starting with 2 shares (one each), think about creating a lot more shares at the start, so that the company already has shares created that it can offer to investors or employees in the future.  Consider starting with 1,000 or even 10,000 shares, and agreeing on a larger number, or a certain %, that will be owned by the founders - or perhaps that will be owned when they 'vest' in an agreed number of months or years (incentivising the founders to stick around and try to make the company a success).

You will also need to file a 'Memorandum of Association' (an agreement to form a company) and 'Articles of Association' (setting out rules for running the company, % votes needed for certain company decisions, etc.), sometimes referred to as the company 'mem and arts'.

 

Forming a company with standard 'off the shelf' documents can be a swift and straightforward process.   You can do this online, or click on the button below and we can help.

However, you may want to put in place bespoke or more detailed Articles of Association to address your particular needs.  There are other key agreements you may want to consider as well, such as a shareholders' agreement, whether at the start or perhaps when you bring on board key investors.  If so, it is well worth seeking legal advice to get this right.

 SHAREHOLDERS vs Directors

A common question is what the difference is between shareholders and directors.  Very simply: shareholders own a part of the company and can vote on major company decisions, whereas directors are responsible for the day to day running of the company.  They are very different roles, with different rights. You can be both.

Shareholders

Shares in a company represent a share in the assets (and liabilities) of the business.  They are privately owned by shareholders, but can be publicly traded if the company becomes listed on a stock exchange.  Shareholders may receive a 'dividend' payment on their shares if the company makes a profit.  Shareholders can vote on major issues affecting the company at the 'Annual General Meeting' ('AGM') or at other specially convened 'Extraordinary General Meeting' ('EGM').  Most issues might need a majority vote (such as removing directors), but the Articles of Association may set a higher threshold of, say >75%, for certain issues (for example changes to the Articles themselves).

Shareholders will typically be the founders, investors (who provide capital in return for shares, or 'equity'), employees, and perhaps also key partners who offer to provide an essential service to get the company going (maybe professional services, such as website development) in return for 'sweat equity' instead of money.

Shares

You can create different classes of shares if needed.  Ordinary or 'common' shares are the default.  These shares generally have good voting rights attached to them, giving a better say in company decisions, but if there are 'preferred' shares held by others, holders of common shares may not benefit from such good dividend payments, and may be further down the queue if the company fails and the shareholders want to recover their investment.  Preferred shares, often sought by investors, often offer greater dividend returns and a better chance of getting their investment back if the company fails - although with fewer voting rights and less influence on company decisions.

Shares can be granted straight away - or can be arranged to 'vest', or be granted via exercise of 'options' or 'warrants,' at a specified time in the future.  This can be a useful way to incentivise people to stay involved and work for the long term success of your company.  When you first set up your company, it is worth thinking about the shares you may want to offer to future employees and investors, and to create enough shares in the first place to be ready for this (so perhaps start with 10,000 shares rather than 1 or 2 - this does not impact on your set-up costs).

Directors

Directors are employed by the company to be responsible for its day to day operations.  Directors sit on the company 'board,' and the board of directors will meet regularly to decide on different company actions.  Major decisions may need to be voted on by the shareholders at an AGM or EGM.  Being a director does not in itself mean you own any part of the company, but you can be a shareholder as well.

 

Founders may take on different director roles.  Typical roles at the start could be a Chief Executive Officer (with overall responsibility, probably dealing with company finances as well), Chief Marketing Officer (business development), Chief Technology Officer (product and technology development).  As the company grows, you may want to take on someone to be Chief Finance Officer specifically.  And so on.

Investors may want to see a number of non-executive directors appointed as well: these are generally people with a lot of industry/professional experience who will not be involved in the detailed day to day activities but who will advise and vote on key issues at board meetings.  

It is worth noting that some investors may ask for both shares ('equity') AND a seat on the board.  This may not actually be appropriate, and it may be sufficient for an investor simply to be a shareholder as they will not be involved in the day to day decisions.  Alternatively, they may be happy with appointing someone to be a board 'observer' who can attend certain board meetings and get a deeper insight into how the company is being run, but without any voting rights.

Directors' Duties

Directors have significant power to direct the business' activities, but with that comes significant responsibilities - to shareholders, employees and third parties with whom the company does business.  Legal and regulatory duties include:

  • When making company decisions, you must act in the best interests of the company, not yourself

  • You must avoid - and declare - any conflict of interest you may have.  For example, if you have any personal connection with a service provider that the company is considering engaging, you should excuse yourself from the directors' vote on whether to go ahead.

  • You must respect and preserve the confidentiality of information concerning the company's technology, finances, business plans etc.

  • You may also be liable in the event of a health and safety incident where the company caused injury or harm to employees or third parties

Breach of these duties can mean personal fines for directors, and even prison sentences for serious breaches.

key agreementS

As well as the basic steps outlined above to form a company, you may want to think about additional agreements with important stakeholders to appropriately manage their interests.  Key agreements include:

Shareholders' Agreement

This is often requested by significant investors, and may be entered into by all or just key shareholders.  It will set out in detail what rights they have, including:

  • % voting rights for key company decisions

  • Information rights: what rights relevant shareholders have to see sensitive information relating to the company's finances, technology, or business operations and plans.

  • Tag-along rights: right for shareholders with small minority % of shares to be involved and sell their shares if other majority shareholders have found a buyer offering a good deal

  • Drag-along rights: right for shareholders with larger majority % shares to involved smaller % shareholders in a share sale if needed (for example if a buyer wants to buy 100% of the shares of the company).

Founders' Agreement

This can be a very useful document to capture what the founders agree between themselves at the outset.  It provides clarity and can help avoid or minimise disputes later on.  Things to be clear on include:

  • Exact role of each founder: what day to day activities will they carry out, their title and likely agreement that they will be a director.

  • What shares in the company they will receive on day one, and what further shares may be vested in them in a defined number of months or years in the future

  • What salary they would receive, either straight away or when the company reaches certain agreed financial milestones (which in turn would be provided for under a Director's Service Agreement - see below)

  • As well as their time and skills, what assets each founder will contribute to the company.  This could be a capital contribution (money), or assignment or licence of essential intellectual property rights in the idea / product / technology underlying the company's business, so that this is safely in the control of the company as a whole and the relevant founder cannot then 'pull the plug' on the business later on if he/she walks out.

Director's Service Agreement

The directors could be founders or others brought in or recommended by investors.  At first, the founders may not take any salary, but as the company grows, a director's service agreement can set out what salary the director will receive, and perhaps what shares will be granted now or that will vest at a future date. This agreement can also set out the role and exactly what the director will be required to do, and also capture the necessary rights the company as employer must offer, as with other employee agreements (see below).

Employee Agreements

 

As you grow, you may want to take on staff who will not all be directors.   Think about what rights you need to offer to these employees and other staff and whether you want to offer incentives such as share options they can exercise if they stay with the company for a certain number of years.

COMPANY ADMIN

Once your company is formed, you will need to stay on top of regular filing obligations at Company House, along with tax returns and other admin.  Things to think about include:

  • Notify Company House as soon as possible of any change in details of shareholders or directors

  • File annual 'Confirmation Statement' at Company House, confirming details of company, shareholders and directors on record are all correct and up to date.

  • File annual company accounts at Company House

  • File corporation tax returns at HMRC 

  • Make sure you have appropriate insurance in place

  • Keep good records of all contracts the company enters into, and keep proper minutes of board and shareholder meetings

See Records, Tax & Reporting for more on records and what / where / when you need to file, and Risks & Insurance for more information on what insurance you might need.