Starting up a new business?

A simple guide to business structures and their suitability for you…

Starting up a new business here is a simple guide to business structures and which one is best for you.

Whether you are starting up a new business venture or simply reviewing your plans for an existing business, it is important to understand which type of corporate structure may be the most appropriate for the ongoing needs and growth of your business. 

The most commonly chosen business structures in the UK are:

  • Sole trader;
  • Partnership;
  • Limited Liability Partnership; and
  • Limited Company.

The above can all be categorised with reference to their initial start-up requirements, position on personal liability and any ongoing filing and tax obligations. Having considered all of the available options, it is often a good principle to start with the simplest structure your business plan will allow for with a view to progressing to a more sophisticated model as your business expands.     

Sole trader

This is the most common and simplest type of business structure. As a sole trader, you run your business as an individual on a self-employed basis which means that all key decision making is in your hands.  Whilst it is possible for a sole trading business to employ further staff, it is often the case that the business operates as a one-person outfit. 

All profits (after tax) are retained by you. These profits are taxed as income by HMRC, and as you are self-employed, you will be required to fill in a self-assessed tax return each year. Other than basic business record-keeping, this is generally the only annual paperwork requirement you will face. 

However, as a sole trader your business is not a separate entity from yourself. As there is no legal distinction between the business and its owner, you will be personally liable for all debts and claims taken against the business. A key factor here is that such liability is unlimited. The major consequence of this being both the exposure of your personal assets and the possibility of bankruptcy.

  Pros

  Cons

  • Easy and inexpensive to set up and register as ‘self-employed’ with HMRC;
  • Not a separate legal entity;
  • You can begin trading immediately;
  • Unlimited personal liability for the business owner;
  • You keep full personal control of business decisions and profits; and
  • Profits are taxed as income, therefore as the business grows your income tax liability may increase; and
  • Very limited annual filing/financial reporting requirements.
  • Can lack credibility in the market.

Partnership

A partnership is another common type of business structure for small businesses. A partnership is formed when two or more individuals wish to enter into a business venture together. Therefore, this type of structure is ideal for individuals who wish to pool their resources to maximise their chances of running a successful business.

A partnership is almost an extension of the sole trader model (with similar set up and ongoing filing/tax requirements), with the additional benefit of having two or more sets of skills and experience at the helm of the business. With any business venture where two or more individuals hold a stake, it is advisable to agree how the ownership and profits are to be split and what is to happen if one partner decides they want to leave the business. All of the above should be provided for in a well drafted Partnership Agreement. 

However, similarly to a sole trader, a partnership is not a separate entity from its owners and therefore this means that all partners are liable for any debts and obligations of the business. An important consideration here is the fact that all partners are jointly liable for the actions of others, meaning that one partner may be responsible for the debt of another if their assets are insufficient to cover the liability. With this in mind, you should carefully consider the conduct of the people you choose to go into business with.

  Pros

  Cons

  • Easy and inexpensive to set up and register each partner as ‘self-employed’ with HMRC;
  • Not a separate legal entity;
  • You can begin trading immediately; 
  • Unlimited personal liability for all partners;
  • Allows for a division in labour;
  • Liability between partners is joint;
  • Very limited annual filing/financial reporting requirements;
  • Possibility for the business relationship to diminish; and
  • Benefit of wider experience and skills sets from different partners; and
  • Profits are taxed as income, therefore as the business grows each partner’s income tax liability may increase.
  • Multiple partners can increase the possibility for capital investment.
 

Limited Liability Partnership (LLP)

LLPs are a newer type of business structure and act as a hybrid vehicle between a traditional partnership and a limited company (discussed further below). LLPs offer the flexibility and tax regime associated with a partnership, together with the limited liability cap available to limited company shareholders. 

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 the business sought to take on any loans.   

As with a general partnership, each partner must register with HMRC as self-employed with their relevant share of profit taxed as income. LLPs also need to be incorporated at Companies House and are subject to more onerous annual filing requirements similar to that of a private limited company. 

As noted in relation to general partnerships, it is highly advisable for all partners of an LLP to enter into a well drafted Partnership Agreement to set out the key tenets that will underpin the partnership such as ownership, profit share and division of liabilities. 

  Pros

  Cons

  • A separate legal entity to the partners;
  • Extensive record keeping and filing requirements in the public domain;
  • Liability limited to investment stake;
  • Profits are taxed as income, therefore as the business grows each partner’s income tax liability may increase;
  • Maximum flexibility for partners;
  • Possibility for the business relationship to diminish; and
  • Allows for a division in labour;
  • Must wait for the LLP to be incorporated before trading can commence.
  • Benefit of wider experience and skills sets from different partners; and
 
  • Multiple partners can increase the possibility for capital investment.
 

Limited Company

Incorporating as a private limited company involves registering at Companies House. This is a move that can improve the credibility of your business in the long term, as well as maximising your business’ borrowing potential. 

The vast majority of private limited companies are owned by their shareholders and are limited by the value of the shares. This means that each shareholder can only be called on to pay the face value of his or her shares in the company if the business were to undergo financial difficulty. This is because a private limited company is a separate legal entity from its owners and therefore has its own profits, debts and liabilities. This cap on liability at shareholder level is a particular advantage for business owners, allowing them to protect themselves from any personal exposure to financial risk.

In relation to day to day management and operational control, the company’s directors are the key players. However, directors are subject to a raft of statutory controls as well as ongoing monitoring by the company’s shareholders. 

This type of business structure has a different tax regime to that of sole traders and partnerships in both forms. Limited companies are subject to corporation tax on their profits, with company directors taxed as employees.

This type of business structure comes with increased administrative duties, including the submission of statutory accounts and a company tax return to HMRC each year together with annual Companies House filing requirements. The accounts and filings are also available for public viewing, making the status of the business capable of being reviewed by competitors.

  Pros

  Cons

  • A separate legal entity to the business owners;
  • Heavily regulated;
  • Liability limited to face value of shares;
  • Extensive record keeping and filing requirements in the public domain; and
  • The corporation survives the death or onward sale of shareholders;
  • Must wait for the company to be incorporated before trading can commence.
  • Corporation tax regime could be advantageous; and
 
  • Improved credibility as a business.
 

If you are entering into a new business venture (either individually or with others) or you wish to expand an existing business, Hunt & Coombs’ Company Commercial Team can advise on the appropriate course of action for you.  With a wealth of experience in business start-ups, the preparation of bespoke partnership and shareholders’ agreements together with business mergers and acquisitions, Hunt & Coombs is on hand to help take your business where you want it to be. 

For further information please contact the Company Commercial Team  on 01733 882800 or email info@hcsolicitors.co.uk

Author

Olivia Chalmers, Solicitor

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This article has been prepared for general interest and information purposes only; it does not constitute legal advice and should not be relied on as such. While all possible care has been taken in the preparation of this article, no responsibility for the accuracy and/or correctness of the information and commentary set out in the article, or for any consequences of relying on it, is assumed or accepted by the firm or the authors.