When you start a business, One of the first decisions that you will have to make as a business owner is how the business should be structured. All businesses must adopt some legal configuration that defines the rights and liabilities of participants in the business’s ownership, control, personal liability, life span, and financial structure. Usually you'll choose either a sole trader, a partnership, a limited liability company (LLC), or a limited company.
There’s no right or wrong choice that fits everyone. Your job is to understand how each legal form works and then pick the one that best meets your needs. The best choice isn't always obvious but the first step to make one is recognizing the options.
Sole Trader: Be On your OwnThis is the simplest way to set up and run a business: ownership and control of the business rests with you. That means you and your business are effectively the same from both a tax and legal perspective.
Being a Sole Trader is inherently risky because you are personally responsible for the business and any debts it incurs. You own all the assets of the business and can dispose any of them as you wish, and may employ staff and trade under a business name. However, it is unlikely that sole trader status will be suitable for businesses that need more than a small level of external investment.
Sole Traders are treated as self-employed by HMRC and must register and make an annual self-assessment tax return – profits from the business are treated as personal income subject to income tax and national insurance contributions. In addition, there is no requirement for a formal constitution for the business, and you don’t need to register or file accounts and returns with Companies House.
Partnership: It takes more than oneA partnership arrangement is similar to that of a sole trader but differs in that it has more than one owner. A partnership can arise, without any formal agreement, when people carry on a business in common, but typically, there is agreement to trade as a partnership. Partners will usually draw up a legally binding partnership agreement, setting out such matters as the percentage of capital contributed by each partner. They will share profits/losses and pay tax based on that percentage. As with a sole trader, each partner’s share of the profits is treated as their income. The partnership itself and each individual partner must make annual self-assessment returns to HMRC, and the Partnership must keep records showing business income and expenses.
The Partnership has no separate legal personality. Partners share the risks, costs and responsibilities of being in business. Because partners generally bear the consequences of each other’s decisions, partners usually manage the business themselves, though they can hire employees. Partners usually raise money for the business out of their own assets or with loans.
Limited Company: The common oneThe Limited Company is the most common legal form in use for running a business. The business becomes a separate legal entity entirely meaning that the company must be formed, or incorporated, and registered at Companies House. It will also have to have certain standard legal documents that govern what it can do and what business it operates in.
A Limited Company is owned and controlled by its members, those who have invested in the business and own its shares. As the name suggests members enjoy limited liability – i.e. the company’s finances are separate from the personal finances of their owners, it facilitates risk reduction if things go wrong. Creditors of the business may only pursue the company’s assets to settle a debt and the personal assets of the owners are not at risk.
Day to day management of a company is nominally separate from its ownership and undertaken by a director or board of directors, with the core principle that they act in the interest of the company and its members. However, directors may also be members, thus the simplest form of Limited Company is a single member who owns the whole company and is also its sole director. A company must have at least one director and at least one director must be a real person.
The Limited Company form is subject to stricter regulatory requirements. This form conveys a more professional image of the business. Greater accountability and transparency is the price to pay for the benefit of limited liability. Accountability is both to the company’s shareholders and also to the public who may wish to deal with the business. Companies are registered at Companies House, and it is the directors’ responsibility to maintain the company’s public records – including annual accounts and an annual return about the company – and to file them at Companies House. They must notify Companies House of changes in the structure and management of the business.
If a company has any taxable income or profits, it must tell HMRC that it exists and is liable to corporation tax. Companies liable to corporation tax must make annual returns to HMRC.
A Company Limited by Shares is either a Private Limited Company (Ltd) or a Public Limited Company (Plc). The key difference is that the Public Limited Company is permitted to offer shares for sale to the public. The Private Limited Company is the most common legal form used by the vast majority of businesses – ranging from a business with a single shareholder director to large companies, which have attracted large investments of private equity capital. Public Limited Companies usually begin life as Private Limited Companies but later go public for the advantage that this provides in raising finance.
A Public Limited Company must have at least two directors and a qualified company secretary. It must have issued shares to the public to a value of at least £50,000. Public companies attract stricter regulation than private companies to ensure transparency and protection for the public investor, who is often more separated from the management of the company than in a private company. A Public Limited Company may also become a Listed Company by floating its shares on a recognised stock exchange, creating a wider market for its shares. Listed companies are subject to even greater regulatory requirements in the form of listing rules and information disclosure requirements put in place to ensure the market works and maintains its integrity.
Limited liability partnership (LLP): More freedom in actionLimited Liability Partnership has some of the same characteristics of a normal partnership, such as the internal management, tax liability and the distribution of profit however unlike in a normal partnership; it also provides the limited liability of an incorporated company. As the name suggests – liability is limited to the amount of money they have invested in the business and to any personal guarantees, they have given to raise finance.
Much like a normal partnership, each non-corporate member of an LLP needs to register as self-employed with HMRC, and both the LLP itself and each individual member must make annual self-assessment returns HMRC. Non-corporate members of an LLP pay income tax and national insurance contributions on their share of the profits.
Additionally, LLPs must register and file accounts and annual returns at Companies House. At least two members must be “designated members” who hold additional responsibilities – it is they who appoint auditors and sign off and file the accounts at Companies House. Limited Liability Partnerships have much more freedom than companies over arranging their internal affairs, in the way in which decisions are made, and the way in which profits are distributed to members. For example, there is no share capital in an LLP. That means new members can be appointed without having to issue new shares. In case of decisions, there aren’t any requirements for those involved in LLPs to make decisions by resolution or to hold board meetings or general meetings as is the case in LTDs.
Limited liability partnerships tend to be used by professional services firms such as solicitors and architects.
Now that you learned your options, just weigh them up, crunch the numbers and choose the best option that fits you.
Quick! The ‘entrepreneurship’ train is calling you.