Which legal structure is best for my business?
New businesses are faced with a choice of several different legal structures. It is critical that you fully understand each option and make the right decision as the legal structure will have an acute effect on the day-to-day maintenance and administration of your company.
The legal structure of your business is likely to affect:
• The tax and National Insurance that you pay;
• The records and accounts that you have to keep;
• Your financial liability if the business runs into trouble;
• The ways your business can raise money;
• The way management decisions are made.
Of course, some firms may start off in one legal structure and then switch to another. However, it is beneficial if you understand all of the pros and cons from the outset to give your business the best chance of succeeding.
Sole trader
Being a sole trader is generally seen as the simplest way of running a business. That said, it can still be slightly risky and can require a great deal of investment.
As a sole trader, you are personally liable for any debts arising from your business activity. Most business owners will be confident of turning a profit when setting up, but it is worth remembering this in case it doesn’t quite go to plan.
Personal liability is undoubtedly the most significant drawback of setting up as a sole trader, but the advantages of this structure can far outweigh this risk. First of all, as a sole trader you get to keep all the profits. This can be immensely satisfying for many business owners, as it means that you are directly rewarded for all of your hard work.
In terms of administration, you just need to keep records showing all your business income and expenses and need to make an annual self assessment tax return to HM Revenue & Customs. As a sole trader, you are not required to pay any registration fees, but will have to register as self-employed.
As you will be self-employed and keep any money you make, your profits will be considered as income and you will need to pay fixed-rate Class 2 and 4 National Insurance contributions on your profits.
Partnerships
A partnership is a relatively simple and flexible way to set up a business. As with sole traders, there is still a personal risk if the business fails, but this risk is shared between partners.
A partnership is comprised of two or more people, who will share any risks, responsibilities and costs for the business. Each partner will be registered as self-employed.
It is advisable to draw up a written contract between partners before business operates with each and every partners signing. Even if you are friends, a contract is vital to protect each individual and ensure that potential disputes are easily resolved in the future.
Like a sole trading company, partners need to raise funds themselves from personal assets or loans. However, it’s possible to have 'sleeping partners’ who contribute money to the business but have no involvement in running it.
Again, as with sole traders, they must keep a record of any income and expenses and complete tax return assessments to HM Revenue & Customs themselves. The same rules apply for National Insurance, too (fixed-rate Class 2 and 4 National Insurance contributions on profits). Profits are split between partners and taxed as their income.
It is important to bear in mind that if a partner leaves the partnership, the remaining partner will then be liable for any debts.
Limited Liability Partnership (LLP)
Limited Liability Partnership (LLP) is very similar to an ordinary partnership. However, the key difference is that liability is only limited to the amount of money you have invested in the business. If your business falls on hard times, each member and their personal assets will be protected.
Each member must be registered as self employed, but there must be two designated members who can take ownership of any issues. LLP’s must also register with Companies House. Under an LLP, responsibilities can be delegated to employees to ensure members do not have to carry them out themselves.
The LLP itself and each individual member must make annual self-assessment returns to HM Revenue & Customs (HMRC) and, unless an agreement specifies otherwise, each member will take an equal share of profits.
Limited Liability Company
The company must be registered with Companies House in order to qualify as a limited company. The main benefit of this structure is that company finances are completely separate to the personal finances of owners.
Limited liability companies consist of shareholders, who are not responsible for company debts unless they have offered personal security against them. There is more than one type of a Limited Liability Company:
Public Limited Company – can have one or more members who buy shares, but shares cannot be offered to the public.
Private Limited company – also known as a PLC. This kind of structure must have at least two shareholders and can raise funds by selling shares on the stock market.
To set up a Limited Liability Company, you must register with Companies House. Directors are responsible for any management decisions and must be over the age of 16 years.
Unfortunately, unlike sole traders and other legal forms, administration for Limited Liability companies can be strenuous. Accounts must be filed with Companies House and audited every year. This must be completed with complete precision and there are significant penalties for companies failing to send in their accounts on time, or are overdue on their tax payments.
Company directors are classed as employees and will pay both income tax and Class 1 National Insurance contributions on their salaries.
