What form should your business take?
The pro’s and con’s of the four main business structures: sole trader, partnership, company and limited liability partnership.
Deciding 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 as creditors can claim against your personal possessions.
A partnership will arise when two or more persons are carrying on a business in common with a view to profit. 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) 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 or her share of the debts the other partners will be responsible for them.
There are no particular requirements 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 but managed by directors (although in small businesses 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 a personal guarantee, for example, to your bank.
With a company there is increased administration including a requirement for certain information to be filed at Companies House, making it publicly available.
A shareholders’ agreement can be put in place to govern the relationship between the company’s shareholders. This may include provisions such as consent rights for matters requiring shareholder approval and information rights for the shareholders. A shareholders’ agreement does not need to be filed at Companies House.
Tax is payable at two points; there will be corporation tax on profits of the company and income tax on those profits when they are paid out to the shareholders as a dividend. This can make using a company a more expensive option.
Limited liability partnership (“LLP”)
An LLP is a hybrid between a partnership and a company. It is made up of individual partners (called members) but is a legal entity with a separate identity from those partners. This means that on the one hand it offers its partners the benefit of 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. Tax is payable by the parties on their full share of the LLP’s profits regardless of whether they have been paid our or retained in the LLP.
As with companies, certain information must be filed by the LLP at Companies House and 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?
If you have any questions about the contents of this article or setting up a business please contact the FSP Corporate Team.