Starting a new business can seem like a daunting task and there is so much to think about.

If you set up a limited company through Magic Beans, the registration process usually only takes a few short hours.  You can then start trading through your new company.

What some new directors may forget is that this new company is, what is commonly called a ‘separate legal entity’ and it’s important to understand what exactly that is.

What is a separate legal entity?

If we look at this in the simplest way and pretend that you have created another person – a little bit like a baby Frankenstein monster.  This ‘person’ – we will call him Bob – can’t walk, talk or even think for himself, but ‘Bob’ can enter into contracts with customers, suppliers, staff and lenders.

Just let that sink in. 

Now, for Bob to start working efficiently he needs two things.

• He needs a director – someone to direct him, sign contracts and make decisions for him;
• He needs a Shareholder – someone who owns him. Everything Bob (your new company) owns his shareholder owns.

The director (or directors) has all the responsibility.  The director has to make all Bob’s decisions for him and they have to ensure they are the right decisions for Bob; not for the director or shareholder personally.

Starting to trade

Let’s assume Bob was created to start selling cars, but he’s having difficulties (he can’t do anything himself remember and he needs guidance).  There are few things that he will need help with:-

• He needs to get to the bank to open a business bank account  – you’re the director so you’ll need to do that for him.
• He needs to enter a contract to buy stock – again you’ll need to do that for him.
• He also needs money to buy the stock – where will he get it?  Can you lend it to him?  Will the bank lend it to him?

We will assume you lend him half and the bank lends him half.  Now he can buy one car, but he needs to sell it.  It is really hard to sell stuff when you can’t do anything for yourself.

Bob really needs an employee and he decides it would be a good idea to employ you, so he enters into a contract (of course, you will have to sign it).

Now Bob is an employer he will need to register with HMRC for payroll taxes.

Bob (the company) will also need someone to process your salary (again, hard to process salary when you can’t walk, talk or do anything for yourself) so he might ask you to do it or he might decide to outsource.

Now you are Bob’s employee things have changed a bit –  you thought you were friends, but he’s produced a company expenses policy and lots of rules for you to follow.

What about personal expenses?

Now the bit that can get even more confusing … Bob isn’t allowed to let you pay your personal expenses from his bank account.  That’s right, “your company” Bob, isn’t allowed to pay for your personal expenses.

Bob has said you have to track your mileage, confirm who, what, when and why.  It may feel like you’re back in your old job and it feels like it’s all hassle but , you start making sales. Hurrah!

There is money in the bank.  Double Hurrah?  But you need all of that money … and Bob needs the money too – he has to repay the bank loan and pay taxes.

But you have bills to pay!

You decide to take Bob’s money (he can’t stop you) but then you need more money!  You’re doing work on your house and you need your garden landscaped.

Bob owes you money, remember, you lent him money to get started!   You decide it is easier for you to pay the bill for your house upgrades from Bob’s (the Company’s) account and he can deduct it from the amount he owes you.

Then a legal fee appears for a personal matter but you you decide legal bills are all business so Bob can pay it, …he deals with all the business stuff.

It is starting to get messy now.  You owe Bob and Bob owes you.  Someone needs to keep track of all the finances.

Bob can’t do it – as the director you’re responsible for it.  You have to keep track of all Bob’s money, calculate his profits, organise his taxes…..  It’s like having a baby monster and like a baby, Bob has legal rights and there are laws to protect him.  As his best friend, his creator, his legal guardian, there are laws to protect him from you.

Always keep everything separate!

When you are a company director, you should never think of anything the company owns as belonging to you (it belongs to your friend Bob).

Think of it like this, if your friend asked you keep an eye on their house while they were on holiday, even if they left you with the keys, you’d never consider it your house; you wouldn’t take their things.  You would just look after them.  It is the same with Bob.

No-one likes being told they can’t do what they want to do with “their business”.  Or worse still they have misunderstood and taken something that doesn’t belong to them and now they have to pay tax, personally, on those amounts.

Always seek advice on creating a “person” – before it becomes Frankenstein’s Monster – and you’re falling out with your accountant because you have misunderstood what you can and cant do when running a limited company.