From Founder To Director: What Changes When You Incorporate?

Setting up a limited company is a big moment. What may have started as an idea, side project or small operation is now officially a company.

But along with that new company comes a new role. If you are appointed as a director, you are no longer just the person building the business and keeping things moving. You now have legal responsibilities for how the company is run and how its decisions are made.

Day to day, not much may feel different. You might still be working with the same people, serving the same customers and tackling the same growing to-do list. Legally, though, your position has changed.

What Changes When You Set Up A Limited Company?

Before setting up a company, you may have operated as a sole trader. In that structure, there is generally no legal separation between you and the business.

A limited company is different. Once incorporated, it becomes legally separate from the people who own and run it. It can enter contracts, own assets and take on debts in its own name.

As a director, you are therefore making decisions on behalf of the company rather than only for yourself.

It is worth making one distinction clear: setting up a company does not automatically make every founder a director. You become a director when you are properly appointed to that role.

A founder may also be a shareholder or employee of the company, but these roles are different. “Founder” describes the person who started the business. A shareholder owns shares in the company. A director holds a recognised legal position with duties under the Companies Act 2006.

In many startups, the same person will be all three. However, being the founder or majority shareholder does not remove the responsibilities that come with being a director.

Who Is Legally Considered A Director?

The clearest example is someone who has been formally appointed as a director. The company must then notify Companies House of the appointment.

However, the legal definition can extend further than the names shown on the public register.

Section 250 of the Companies Act 2006 defines a director as including anyone occupying the position of director, whatever title they use. Someone who effectively performs the role may therefore be treated as a de facto director, even if they were never properly appointed.

Section 251 also recognises shadow directors. Broadly, this is someone whose directions or instructions the appointed directors are accustomed to follow. A person will not become a shadow director merely because the board follows advice properly given in their professional capacity.

This could matter where one founder is formally appointed while another continues making the company’s major decisions behind the scenes. Calling yourself an adviser, consultant or founder will not necessarily prevent you from being treated as a director if your actual role suggests otherwise.

In other words, the law looks at what you do, not just the title you use.

A New Companies House Requirement

Directors must now verify their identity with Companies House.

A new director must provide their Companies House personal code as part of their appointment filing or when the company is incorporated. Existing directors must provide their code through the company’s next confirmation statement during the transition process.

The personal code connects the director’s verified identity to each company role they hold. Failing to complete the required verification on time can result in penalties or other enforcement action.

What Are The Seven Duties Of A Company Director?

Sections 171 to 177 of the Companies Act 2006 set out seven general duties owed to the company.

They apply to formally appointed directors and can also apply to someone acting as a de facto director. They may also apply to a shadow director, although only where and to the extent that the particular duty is capable of applying to that person’s role.

An appointed director cannot avoid their duties simply by remaining inactive or following someone else’s instructions.

Act Within Your Powers

Directors must act in accordance with the company’s constitution and only use their powers for the purposes for which they were given.

The company’s constitution includes its articles of association, which contain rules about how the company is run. Before issuing shares, approving a major transaction or making another important decision, a founder-director should check that they have the authority to do so and follow any required approval process.

For example, a director should not issue new shares mainly to reduce a co-founder’s voting power if that is not a proper use of the power to issue shares.

Promote The Success Of The Company

A director must act in the way they consider, in good faith, would be most likely to promote the company’s success for the benefit of its members as a whole.

In making that decision, the director must have regard to matters including the likely long-term consequences, employees’ interests, relationships with customers and suppliers, the impact of the company’s operations on the community and environment, its reputation and the need to act fairly between members.

For a founder, this means recognising that what benefits them personally may not always be what is best for the company and its shareholders as a whole.

Exercise Independent Judgment

Directors must use their own judgment when making decisions for the company.

They can listen to co-founders, investors, employees and professional advisers, but they should not simply allow someone else to control how they exercise their powers.

An investor may have strong views about the company’s direction, for example, but an appointed director must still consider the matter and reach their own decision. This does not prevent directors from acting in accordance with the company’s constitution or a valid agreement that properly restricts their discretion.

Exercise Reasonable Care, Skill And Diligence

Directors must exercise the care, skill and diligence expected of a reasonably diligent person carrying out their role.

The standard also takes account of the director’s own knowledge, skill and experience. A founder with particular financial, technical or legal expertise may therefore be expected to use that expertise when making relevant company decisions.

In practice, this means reading important contracts, understanding major commitments, asking questions where information is unclear and considering the risks before approving a decision.

Not every commercial decision will succeed. A poor outcome does not automatically mean the duty has been breached. The question is whether the director approached the decision with an appropriate level of care.

Avoid Conflicts Of Interest

Directors must avoid situations in which they have, or could have, an interest that conflicts with the company’s interests.

This is particularly relevant for startup founders who have several businesses, investments or side projects. A conflict could arise where a director wants to pursue a company opportunity personally, use company resources for another venture or direct work to a separate business they own.

The duty expressly covers the use of company property, information and business opportunities. In some circumstances, a conflict may be authorised if the Companies Act and the company’s articles allow it and the correct approval process is followed.

Having a potential conflict does not necessarily mean the director has done something wrong. Problems are more likely to arise when the conflict is hidden, ignored or handled without proper approval.

Do Not Accept Benefits From Third Parties

A director must not accept a benefit from a third party because they are a director or because of something they do - or choose not to do - in that role.

For example, a supplier should not offer a director a personal commission, expensive gift or other incentive in return for receiving a company contract.

A benefit will not necessarily breach the duty if it could not reasonably be regarded as likely to create a conflict. Even so, directors should approach personal benefits carefully and follow any company policies or approval processes.

Declare Interests In Company Transactions

Where a director is directly or indirectly interested in a proposed transaction or arrangement with the company, they must generally declare the nature and extent of that interest to the other directors before the company enters the transaction.

This could apply where a director owns a business being considered as a supplier, has a financial interest in a proposed deal or is involved in setting their own remuneration. A separate declaration may be required where the company has already entered the transaction and the interest was not properly declared beforehand.

Declaring the interest does not automatically make every transaction acceptable. The director must still comply with their other duties and follow the company’s articles and any relevant approval requirements.

Can You Leave Things To A Co-Founder Or Accountant?

Startup founders often divide responsibilities according to their strengths. One founder may handle sales and partnerships, while another manages the product or finances.

There is nothing inherently wrong with dividing the work. Directors can also hire accountants, lawyers and other advisers to help the company.

However, delegation does not remove a director’s legal responsibility. Companies House makes clear that directors remain responsible for the company’s records, accounts and performance even where another person handles those matters day to day.

A director cannot necessarily avoid responsibility by saying that their co-founder handled the figures, the accountant prepared the accounts or they were only focused on the product.

All directors share responsibility for the company, including those who are not closely involved in its daily operations. They should remain involved in important decisions, review the information they receive and ask questions where something does not appear right.

A company must also keep adequate accounting records showing and explaining its transactions and giving a clear picture of its financial position. Directors are responsible for making sure required records, accounts and company information are properly maintained and filed.

This does not mean every founder needs to become a financial expert. It does mean they should understand the company’s general financial position, major debts and upcoming commitments rather than relying entirely on someone else.

What Changes When The Company Faces Insolvency?

Directors normally exercise their duties for the benefit of the company’s members as a whole. However, their decision-making responsibilities can change when they know, or ought to know, that the company is insolvent or bordering on insolvency, or that insolvent liquidation or administration is probable.

At that point, directors may need to consider and give appropriate weight to the interests of the company’s creditors as a whole. The worse the company’s financial position becomes, the greater the weight that may need to be given to creditor interests. Where insolvent liquidation or administration becomes inevitable, creditors’ interests become paramount.

This remains a duty owed to the company. It is not a separate duty owed directly to each individual creditor.

Warning signs might include regularly missing payments, being unable to meet payroll, facing persistent demands from creditors or relying on uncertain future funding to pay debts that are already due.

A temporary cash-flow problem does not automatically mean a company is insolvent. However, directors should understand the company’s position and seek qualified advice early rather than continuing as normal without a realistic plan.

What Is Wrongful Trading?

For companies in England, Wales and Scotland, wrongful trading may result in a director being ordered to contribute personally to the company’s assets.

Broadly, this can happen where the director knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation or administration, but failed to take every step they ought to have taken to minimise potential losses to creditors. Section 214 of the Insolvency Act 1986 addresses wrongful trading in liquidation, while section 246ZB covers administration.

The law does not necessarily require directors to stop trading the moment financial difficulty appears. In some cases, continuing to trade may produce a better result. The decision should, however, be properly informed, regularly reviewed and focused on minimising losses to creditors.

Northern Ireland has separate insolvency legislation containing similar wrongful-trading provisions, so local advice may be required.

What Can Happen If A Director Breaches Their Duties?

The consequences will depend on the duty involved, the seriousness of the conduct and the loss caused.

Depending on the circumstances, a director may be required to compensate the company, return company property, account for a personal profit or have a transaction set aside. The civil consequences generally reflect those that applied to the equivalent common-law and fiduciary duties before they were set out in the Companies Act.

A breach of one of the seven general duties is not automatically a criminal offence. However, separate company, insolvency, fraud or other offences may carry criminal consequences.

Serious misconduct can also lead to disqualification from acting as a company director for up to 15 years.

This does not mean directors should become afraid to make decisions or take reasonable commercial risks. A decision is not automatically a breach simply because it produces a poor result.

The focus is on how the director acted: whether they followed the company’s rules, used their own judgment, considered the relevant information and managed personal interests properly.

Getting The Director Role Right

Directors’ duties are easier to manage when clear processes are put in place early.

Read important contracts before approving them. Keep records of major decisions and raise potential conflicts as soon as they arise. Stay familiar with the company’s finances, even where another founder or accountant manages the day-to-day records.

It is also important to understand what the company’s articles of association allow directors to do. A shareholders’ agreement can provide further clarity around founder roles, decision-making, share issues and what happens when the founders disagree.

These documents do not replace the duties imposed by law. However, they can make it easier for founders to understand their authority and avoid important decisions being made too informally.

From Founder To Director

Setting up a limited company may not change what your working day looks like. You may still be speaking with customers, developing the product and trying to work through a never-ending list of priorities.

What changes is the legal position you hold while doing those things.

Once appointed as a director, you are making decisions for a separate company. You must follow its constitution, promote its success, exercise your own judgment, act with appropriate care and manage conflicts properly. You must also remain informed and respond early if the company begins facing serious financial difficulty.

If you are forming a limited company or bringing a co-founder into an existing business, getting the right legal foundations in place can make these responsibilities easier to manage. A legal expert can assist with company formation, articles of association, shareholders’ agreements and other arrangements setting out how the company will be owned and run.

If you would like a consultation on your director duties, you can reach us at 08081347754 or team@sprintlaw.co.uk for a free, no-obligations chat.