For anyone starting a business, it’s important to lay the best possible groundwork for its launch. However, selecting the wrong business structure can cause things to go awry for your startup right from the beginning.
Ultimately, the structure you pick will determine how long it takes to get your business trading, as well as its obligations with regards to accounting and tax. With that in mind, here’s a simple guide to the business structures available to new companies.
A sole trader, as the name suggests, is a single individual running his or her own business. Although they can employ staff, they are the only person running the business and are solely responsible for its success or failure.
The first advantage of operating as a sole trader is that you have full control of your business and can run it as you please. It also allows you to retain all profits without paying out dividends. While registered companies are required to publicly disclose their information, sole traders enjoy complete privacy and aren’t subject to as much paperwork.
However, because a sole trader is not seen as a separate entity from their company, it is therefore subject to unlimited liability. This means that the individual running the business is held responsible for the company’s debts and is personally prosecutable for any liabilities. Being a sole trader also makes it hard to gain enough credibility to raise finance or take advantage of economies of scale in the same way as a limited company.To set up as a sole trader, you need to register for Self Assessment and file an annual tax return. You’ll also need to register for VAT if you earn more than £85,000 per year.
A partnership is a group of people, ranging from two to 20, that have shared responsibility over a business. To become a partnership, you just have to register with HM Revenue & Customs. If your revenue exceeds £85,000, you’ll also have to register for VAT.
The advantages of a partnership are basically the same as a sole proprietorship. Taxes are easy to report, there is limited bureaucracy, and it’s easy to set up and operate. As all partners fund the business, raising capital is generally easier than it is for a sole trader. With multiple owners, a partnership also has the advantage of shared responsibility, meaning work can be split according to each individual’s skills.
Like sole traders, partnerships have unlimited liability, meaning their personal income will suffer if the business fails. By its very nature, a partnership also brings a higher risk of disagreements. Tax must be paid in the same way as sole traders, with each partner having to register as self-employed and submit a Self Assessment tax return every year.
Private Limited Company
A private limited company is considered a legal entity in its own right and is separate from its owners. This means that the founders can keep their assets and finances separate from the business itself. After corporation tax is paid, a limited company shares its profits with its members.
As a private limited company, you must:
- register with Companies House (obtaining a Certificate of Incorporation) and submit yearly returns;
- compile annual statutory accounts;
- send HMRC a Company Tax Return. Directors must fill out Self Assessment tax returns and pay tax and National Insurance if they receive salaries;
- register for and pay current VAT rates if your takings exceed £85,000 per year.
The main advantage of a private limited company is that owners are subject to limited liability, meaning creditors can only seek payment from the actual company, not its owners. This, in turn, can give customers and suppliers more confidence in the business. Indeed, many large organisations only deal with limited companies.
The drawbacks of limited companies are that there is a lot more paperwork to file, and the company information must be on public display. There is also a possibility of further taxation on capital gains if appreciating assets are withdrawn from the company at a later date.
Limited Liability Partnership
A limited liability partnership (LLP) is a hybrid between a partnership and a limited company. It requires a minimum of two partners, but there is no maximum limit.
LLPs share the advantages of private limited companies and partnerships. They are subject to limited liability but also have the flexibility to operate in a way that’s determined by the partners. They can designate members, and not all partners need to be at the same level (senior or junior).
Despite this, LLPs are subject to public disclosure: financial accounts need to be submitted to Companies House for the public record. The income of every individual partner is taxed, and profit cannot be retained in the same way as a private limited company. There’s also no flexibility to hold over profit for a future tax year.
Understanding the pros and cons of each business structure should help you decide which is the best fit for your business. Should your circumstances change down the line, you can always change your structure to one that’s more beneficial. Don’t worry: it’s allowed.
About the author
Victoria Cimaz manages content and outreach at Linkilaw, the online platform that provides startups with cost-effective and streamlined access to legal services.