What form should your business take?
This article explains the pro’s and con’s of the four main business structures: sole trader, partnership, company and limited liability partnership.
The decision as to which structure is the most suitable for your business will depend on the type and size of your business and your long terms plans. It can seem overwhelming with so much to think about, but hopefully we can give you a better understanding of the options available to you and what they all mean.
This is the simplest structure, being the easiest to start up and to run. As a sole trader you will be in business on your own, operating as self-employed and paying income tax and national insurance contributions (NICs) based on your own net profits. If you have employees you will also need to deduct tax and NICs from their salaries.
As a sole trader you will be personally responsible for all liabilities of the business and the only way that you will get credit for your business is in your own name. You are at risk of bankruptcy if anything goes wrong and creditors can claim against your personal possessions.
A partnership can arise where two or more people are in business together, dividing the profits and losses of the business between them. If you run your business through a partnership then profits will go directly to each partner (in other words they don’t accrue to the partnership first, as happens with a company) and each of you will pay tax on your share of the profits as a self-employed person.
Partnerships suffer the same disadvantage as sole traders in that the partners have to raise credit in their personal capacities and they are personally liable for the debts of the business. This liability is joint and several between the partners so if one cannot cover his share of the debts the other partners will be responsible for them.
There are no particular requirements needed to set up a partnership, although it is recommended that you have a Partnership Agreement at the start so that all the partners are clear on their rights and responsibilities. In particular you ought to agree what happens if one partner leaves the business.
A company is owned by shareholders and managed by directors (the directors and shareholders are often the same people). It is a legal entity in its own right and so allows you to keep your business separate from your personal affairs. This means that the company can borrow any finance needed, and your own liability will be limited to the amount you invest in the company. The exception to this is if you need to give personal guarantees, for example, to your bank.
Using a company can be seen as more formal and there is increased administration with certain information needing to be filed at Companies House (so becoming publicly available). It is possible to keep some information private by using a shareholders’ agreement to govern certain terms; and as with a partnership you will probably want to set out what happens if one shareholder leaves the company.
Tax is payable at two points; there will be corporation tax on profits at the company level and there will then be income tax on those profits when they are paid out to the shareholders. This may not be so bad if you intend to keep your money in the company, but if you want to take out money for your personal living costs then using a company could be an expensive option.
One other thing to think about with a company is that it will be run by directors, who may or may not be the same people as the shareholders. Directors have various obligations and liabilities of their own which means you need to comply with certain strict requirements for the management of the company.
Limited liability partnership (“LLP”)
An LLP is a hybrid between a partnership and a company. It is made up of individual partners but is a legal entity with a separate identity from those partners. This means that on the one hand it offers its partners limited liability as if it were a company; and on the other hand it allows money to go direct to the individual partners as if it were a normal partnership.
As with companies, certain information must be filed by the LLP at Companies House. However, the partners can set out the terms of their relationship in a private LLP agreement.
What to think about?
When deciding on the business structure for you, you should consider the following points:
- How are other businesses similar to mine usually set up and what structure will my customers expect to see?
- Do I want to limit my personal liability for debts of the business?
- What are the financial requirements of my business likely to be?
- How much money will I need to take from the business for my own living costs?