We look at how to choose the right legal structure for your start-up
You’re ready to start your new business, but have you considered how the decisions you make now will affect its growth? One of the earliest is company structure: we look at the pros, cons, ongoing filing and tax associated with the four main start-up structures, to help you decide which is right for you.
Unless it’s part of the business plan to raise significant funds on the stock exchange within a defined period, you probably won’t want to start off as a public limited company (PLC), so it’s a four-way crossroad: become a
Sole trader, form a partnership, or
incorporate a limited liability company Ltd, or
Partnership (LLP) at Companies House.
The advantages of registering as a sole trader
If you are not going to employ anybody you will probably be best as a sole trader. This is because:
1. There are no dues or fees to register
2. You can go straight out and order your business cards.
3. Most new businesses are set up this way – it is easy
4. It is inexpensive
5. There is very little in the way of red tape.
While a sole trading business can employ staff, most are one (wo)man bands, and most operate in service sectors, such as photography, hairdressing, construction and business-related services.
As a sole trader any decisions you make will be instant, ideal if you have been frustrated by having to convince colleagues or board members while competitors steal your market advantage. More importantly, everything you make belongs to you alone (after tax).
The disadvantages of registering as a sole trader
However, on the flip side, the law makes no distinction between the business and its owner: liability is unlimited, meaning any business debt can be met from the owner’s personal wealth if the business fails.
Meanwhile, the business won’t usually continue in the event of the owner’s retirement or death. As a sole trader, your profits are taxed as income, and as you are self-employed, your tax will be self-assessed. But you should be no worse off than you were as an employee [working for someone].
Forming a partnership
A partnership is for you if you are offering services with people you know well. Many building and domestic services firms are either sole traders or partnerships, but bear in mind that if you hope to gain sub-contract work from larger companies you may need to incorporate to satisfy their guidelines.
Partnerships are a very common extension of the sole trader model, for example when two individuals or a husband and wife work together to build the business. The partnership is just as flexible, has the benefit of two or more heads, and the business won’t collapse if one of you is sick or needs a holiday.
There has to be an agreement as to how the liabilities, ownership and profits of the business are split and what happens if one partner wants to leave, which should be enshrined in a partnership agreement. However, the only legal requirement, as with a one-person business, is that each partner is registered as self-employed and puts in a separate tax return.
In a standard partnership, as with sole traders, all partners are also responsible for all the debts owed by the business. This doesn’t only apply to debts you have incurred as a partner but to those of any partner, so you need to pay particular care to the conduct of the people you go into business with.
Incorporating a limited liability company (Ltd)
Incorporating means registering a limited company or LLP at Companies House: it’s a move that will lend credibility to the business. It may also make it easier to borrow money when the time comes. But do look carefully at your motives: being the managing director of a limited company may bring status, but you may regret the move when struggling with the year-end accounts.
Once you register at Companies House as a private limited company you are letting yourself in for more administration. But it is not as daunting as it used to be – these days you can be the sole shareholder and director, and act as company secretary too (although appointing a company secretary is no longer a legal requirement).
Most private limited companies are owned by their shareholders and are limited by shares. This means that the face value of their share in the business is the most they can be called on to pay if things go wrong.
The great advantage of limited liability is that you can control your exposure to financial risk. There’s a firewall between your money and the company’s. This is because a limited company is a separate legal entity to the company directors, therefore it is the business itself that shoulders the financial liability if the business goes under. Your home, your family and your lifestyle are protected.
Incorporating a limited liability partnership (LLP)
LLPs are Britain’s newest business vehicle especially suited to professional services companies. They may be seen as a hybrid between limited liability companies and traditional partnerships, in that they offer the limited liability available to limited company shareholders combined with the tax regime and flexibility available to partnerships. The number of partners is not limited but at least two have to be ‘designated members’ responsible for filing annual accounts.
Just as with a limited company the LLP model protects its members’ assets, limiting their liability to however much they have invested in the business and any personal guarantees they may have given when raising loans. But it doesn’t give you the same tax advantage.
Business legal structure checklist
|Sole trader||Low cost, easy to set upFull control retainedVery little financial reporting||Full liability for debtPay more in taxLacks credibility in market|
|Partnership||The above, but with more headsMore potential to raise finance||The above, affecting all partnersCan be messy to wind up|
|Limited company||Less personal financial exposureFavourable tax regimeAbility to work for corporate clients||Administrative and regulatory demands heavierAnnual accounts and financial reports must be placed in public domain|
|Limited liability partnership (LLP)||Flexibility: can be incorporated in members’ agreementAdvantages of limited company and partnership combined||Profit taxed as incomePartners must disclose incomeLLP must start to trade within a year of registration – or be struck off|
Please speak to a lawyer in regards to setting up your company for legal and up-to-date information on this