What Are the Most Common Mistakes When Running a Limited Company?

Elizabeth Wilkinson

Many business owners start companies with friends, family members or long-time colleagues. While those relationships may provide a strong foundation, they offer little protection when disagreements arise, responsibilities become unequal or the business comes under financial pressure. We regularly advise business owners whose working relationships have broken down, often because important legal and financial safeguards were never put in place.

As well as managing all the operational challenges and generating revenue, it is important that directors and shareholders understand their legal responsibilities, keep company and personal finances separate, document key decisions properly and recognise when financial difficulties change their duties.

This article highlights five common mistakes that can expose business owners to disputes, penalties and personal liability and explains how to avoid them.

How can directors avoid misusing company funds?

Although perhaps an obvious sounding point, company cash belongs to the company, not to its directors.  Directors cannot treat the company’s bank account as if it were their own even if only in the short term and even if they own part of the company.

What are the most common mistakes when directors use company money?

• Taking unauthorised and or documented “drawings” throughout the year. Directors cannot simply transfer money out when wanted.
• Overdrawn Directors loan accounts face heavy tax penalties if not repaid within the required timescale.
• If the company lends money to a director over a certain threshold, it creates a taxable benefit-in-kind.
• Director/shareholders often receive remuneration via PAYE and by way of dividend to be tax efficient. The company’s Articles of Association (its internal rulebook) and any Shareholders’ Agreement must allow this, especially if directors are not all remunerated in the same way.
• Directors’ remuneration must be approved by the Board.

What can happen if a director misuses company funds?

A director may well have to repay the money out of his own pocket and even face court action to force him to buy other directors’ shares

When is a dividend unlawful and how can directors avoid paying one?

Common errors are:

• Declaring dividends without sufficient retained profits. Dividends can only be paid from accumulated, realised profits (distributable reserves).
• Relying on bank balances instead of up-to-date accounts. A healthy cash balance does not automatically mean the company is (legally) profitable.
• Failing to write down formal dividend minutes. Dividends should be approved by the board and a resolution signed. The Articles of Association and any Shareholders’ Agreement must permit the dividends being declared. This is particularly important if different shareholders are to receive different levels of dividend, perhaps due to their varying levels of involvement in the company.

What can happen if a company pays unlawful dividends? A director may well have to repay the money out of his own pocket and even face court action to force him to buy other directors’ shares.

Muddling the “Hats” – What is the difference between a director and a shareholder in a limited company?

Directors manage a company’s daily operations; shareholders own the company. They are governed by different laws and have different rights, responsibilities and liabilities.

• A director must promote the success of the company and not their own, especially if it conflicts with the company’s interests.
• It is possible for directors to do business with the company, but this must be declared formally and the Articles of Association followed.
• Major decisions should not be made by just the board without the formal support of the shareholders. Some decisions require over 50% such as declaring dividends and approving the accounts whilst others require a 75% shareholder majority such as when changing the Articles of Association – the company’s internal rulebook.

What can happen when directors and shareholders confuse their roles? A director may well have to compensate the company for benefits he gained or lose shareholder support and his position on the board.

Ignoring ‘admin’ – Why are company records and legal agreements important for owner-managed businesses?

Whilst the admin or paperwork may not be the most interesting part of the job, it is critical and the absence of the right paperwork can lead to fines, threats to strike off the company at Companies House and even potentially ruinous court claims.

• Missing statutory filing deadlines with Companies House such as forgetting confirmation statements or accounts leads to automatic fines and risks the company being struck off the register at Companies House. Banks and suppliers can take a dim view of this.
• Even sole director-shareholders must document key decisions in writing to satisfy HMRC.
• The number 1 problem we see is that former friends or close family members did not think that formal legal agreements were necessary but, once the disagreements start, they find themselves wholly unprotected and with very little right of recourse in a business ‘divorce’. Relying on the basic Model Articles of Association leaves all concerned at risk but especially when it is a 50/50 split in the shareholding.  Deadlock at director and shareholder level can occur, paralysing the company.

What should a bespoke shareholders’ agreement cover? A bespoke Shareholders’ Agreement is a must and can set out specific agreements about what happens if:

• someone wants to leave or is forced to leave
• directors have different roles and levels of workload and responsibility; how is that is to be rewarded differently as, if not, resentment can soon build
• there is deadlock in a 50/50 company. Without a dispute resolution clause, the company cannot act.

What should directors do when a company may be insolvent?

Continuing to trade while knowing the company is insolvent can drag unwary directors out to the sea of “wrongful trading” which can carry severe, personal penalties.

• When cash begins to run out, a director’s legal duty flips from helping the company’s shareholders to protecting people to whom the company owes money, creditors. Failure to do so can result in claims against directors personally for compensation.
• The order in which the directors pay creditors is also very important. If a director pays (or prefers) friends or the bank for an amount which the director personally guaranteed first ahead of others, he may well find himself reimbursing that amount from his own pocket.

How Bermans can help

If you are starting a business with others, reviewing your existing arrangements or facing a disagreement with fellow directors or shareholders, taking advice early can help prevent costly disputes and protect both the company and your personal position.

Whether you need assistance with shareholders’ agreements, directors’ duties, company governance, dividends or business relationship breakdowns, our Litigation team can provide practical, commercially focused advice tailored to your circumstances.

Contact our Litigation team to discuss how we can help safeguard your business and avoid problems before they escalate.