October 28, 2020
There is much excitement when you think of establishing a new start-up but there are many challenges as well that need to be dealt with. One of the first challenges is to answer the question ‘What will be the most optimal legal structure for my business’?
The decision you make is significantly going to impact the amount of administrative work you are going to get yourself involved in, quantum of tax that you pay, degree of personal liability (if the business suffers losses) and your ability to raise finance in the future as well. Hence it is imperative to choose a structure that perfectly suits your business needs.
Also, choosing the correct structure from the outset will save you from many headaches later on as solving complications that may arise in the future involve significant costs and require extensive professional advice to move to an alternative business structure.
Although, there are business structures such as Offshore companies, Cooperatives and Franchises, but let us look at the 4 main types of business structures that exist in the UK and their pros and cons.
It is a popular and a simple option for many start-ups who don’t have a lot of capital to invest. As a sole trader you can start trading immediately and you can enjoy the profits generate, but also are liable for losses if any. Also, a sole trader is considered to be a ‘self employed’ individual and this means you must register with HMRC as soon as you begin trading and complete your tax return every year. Although the name may mislead you, but as a sole trader, you can employ staff. Also, you have to pay income tax and NIC on the profits earned.
1. You can take your own quick decisions and not obliged to take others’ opinions. Complete control over your business.
2. Easy to set up and inexpensive.
3. Almost zero red tape and no fees to register.
1. You are personally responsible for all debts accrued, so your personal assets would be at risk if your business runs into trouble.
2. Also, you would be personally liable if a customer sues you as you are not a separate entity from your business.
Partnership structure is almost similar to the sole trader structure. Unlike one owner, here, there can be two or more people running the show. It is governed by partnership agreements. As a sole trader, partners share costs, profits (as per the agreement), pay taxes on them and also pay NIC if the stated thresholds are breached. They are personally liable for any debt accrued. Also, each partner needs to register with HMRC and complete the tax return every year.
1. Easier to create, own and manage the business.
2. Advantage of mutual support and sharing of responsibilities.
3. As required of limited companies, no need to intimate Companies House.
1. Even if one partner has invested more, but the other partner incurs debts, then all partners are equally and personally liable towards that debt. Creditors can claim personal assets from you to pay off that debt. Hence, partners need to be trustworthy to run partnership business.
2. If one partner leaves then the others are liable towards debt if any. Also, if one partner goes bankrupt, dies or resigns then it must be dissolved immediately.
3. Winding up a problematic partnership can be painful, time consuming and a costly affair.
Limited Liability Partnership (LLP)
It has the best elements of both ‘Partnership’ and a ‘Company’. In an LLP, there is no limitation on the number of partners, but at least two should be ‘designated members’ responsible for filing annual accounts. As with a limited company, an LLP is a separate legal person and can enter into contracts in its own name, it has to also register at Companies House. Just as a company, a member’s liability is limited to the money he/she has contributed and also each member’s share of profit is taxed. Each member should be registered with HMRC.
1. Unlike ‘Partnership’ structure, the liability of each member is limited.
2. More flexible by way of additions in the agreement.
3. Best mix of both ‘Company’ and ‘Partnership’ structures.
1. Trading must start within one year or the name is struck off the record in the Companies’ House.
2. Disclosure of income by partners is mandatory.
Limited Liability Company
A limited liability company is a separate legal entity from the people who run it. The personal assets of the people who run the company are protected even if the company suffers losses. This effectively means your money is separate from the company’s and thus liability is limited to the shares you own.
Before you start trading, you have to register the company with Companies House, decide on the name of the company and the people who will run the business. Registration will not only lend credibility, but also makes borrowing money easier. One person or multiple people can own and manage the company depending on the shareholding pattern. Shareholders may own varying proportions of the company and can have different rights. This structure enjoys favourable tax regime. The company pays corporation tax on its profits and the company directors are taxed as employees in the same way as other people who work for the company.
1. Limited liability. If the company suffers losses, then the creditors can take control of the assets of the business but not from the owners. Thus, owners are not legally responsible to pay for the losses beyond the quantum of shares owned by them.
2. Greater credibility so easy to raise finance from the market.
3. Selling part of the business is easier.
1. Very expensive to set up and register as compared to previously discussed business structures.
2. Prepare financial reports and annual accounts and place the same in the public domain. This is lengthy, time consuming and costly affair.