Whether a new venture or an existing entity, there are several ways to structure your business, each of which may offer their own advantages and disadvantages. The most common structures for small and medium enterprises (SMEs) are: sole trader, partnership, limited liability partnership and private limited company.
It is important to take tailored advice, both from a financial and legal perspective, when considering the best structure for your business. A summary of each of the most common structures is noted below:
Sole Trader
Setting up as a sole trader is the simplest way to start a business. You will need to advise HMRC (HM Revenue & Customs) that you are self-employed and then account for your income and expenditure through the annual self-assessment.
Though many sole traders may work alone, you are still able to employ staff subject to any regulations governing your trade or profession. You will also be able to enjoy the flexibility of making instant decisions.
However, the tax thresholds for your income may become unfavourable as the business begins to flourish. Additionally, your personal liability is unlimited and thus any business debt can be met by your personal assets if the business were to fail – this could leave you exposed to potential bankruptcy. Furthermore, it is often not straight forward to transfer a sole trader’s business upon retirement or death; it is advisable to ensure you have a will draft which fully accounts for your wishes.
Partnership
If you want to start a business together with at least one other individual, then a partnership may be a
suitable option. This is a common extension of the sole trader model, being as flexible but with the added input of at least one further business head. A nominated partner is responsible for managing the partnership’s tax return and keeping relevant business records.
It is advisable to ensure that the division of responsibility, liability, and profits are expressly defined within a partnership agreement, in the absence of which the Partnership Act 1890 is applied.
As with sole traders, all partners within a standard partnership are jointly and severally liable for all the debts owed by the business. Your share of profits is taxed as income also.
Limited Liability Partnership (LLP)
LLPs are most often associated with professional service companies such as accountancy firms and solicitors. LLPs are somewhat of a fusion between traditional partnerships and limited liability companies – they offer the structural flexibility and the same tax regime of a partnership, whilst providing members with limited liability much like company shareholders.
The partners’ assets are protected, limited to the value they have invested into the business plus, of course, any personal guarantees they may have provided. As with sole traders and standard partnerships, each member must register with HMRC as self-employed whilst the LLP itself is registered at Companies House. There are increased administrative responsibilities compared to sole traders and standard partnerships.
Private Limited Company
A limited company requires a slightly more complex formation process and there are increased administrative accountabilities compared to those of, say, a sole trader. However, this is often not as onerous as some people may imagine.
Below are some of the key characteristics of a limited company:
- Limited Liability – Assuming there is no fraudulent activity, a company’s directors and shareholders are protected by the limited liability status of the company.
- Distinct Identity – A company has a distinct legal personality and can own assets, enter contracts, and has its own bank accounts.
- Tax – You may find that there are tax advantages to operating out of a limited company. Specific advice should always be sought from a qualified accountant or financial advisor when considering how business structures will affect your tax liability.
- Corporate Image – A limited company can often suggest a more professional overall image, particularly within certain sectors. Some suppliers and customers may prefer to deal with limited companies over sole traders for example. Furthermore, once your name is registered with Companies House it is protected to avoid the same name, or any name considered similar, to be used.
- Exit Planning and Succession – Should a shareholder wish to retire, sell his shares, or dies it is much easier to transfer ownership of their interest in a limited company than, for example, a sole trader entity.
Summary
When considering the most appropriate structure, each business should be assessed on its own merits and the growth strategy of the business owner should be considered. Once you have taken specialist legal and financial advice, regardless of the business structure you adopt, it is also important to ensure that you have made provision for: standard terms of business (T&Cs); contracts of employment and employee policies; a formal agreement between partners or shareholders; and considered long term goals and exit strategies within your business planning as well as accounting for succession within your will.
For further information on business structures or any commercial matters, please contact the Company & Commercial Department.