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In the UK there are four main ways you can structure your business:

  • as a sole trader;
  • in partnership with one or more other people;
  • as a limited company; or
  • as a member, with one or more persons or companies, of a Limited Liability Partnership.

When deciding on the appropriate structure for running your business the following points should be considered:

Sole Trader

Advantages:

Easy to set up and start trading. You will need to open a business bank account – it really isn’t a good idea to mix your personal and business cash – and inform HM Revenue & Customs. You can get details of how to do this here.

Trading as a sole trader can be tax efficient when money is taken out of the business and there is the potential to pay lower Income Tax & National Insurance contributions. However this must be balanced against the lower benefits available to the self-employed.

There is a lower compliance burden on sole traders than on other structures: No annual returns, minutes, registers etc.

You can change your mind and transfer to a Limited Company quite easily and with no adverse tax implications.

Disadvantages:

You have unlimited liability – if your business fails your private property, including your house and all your possessions, can be claimed by those to whom you owe money.

Your business may lack credibility particularly if you are dealing with large companies, or entering contracts.

Partnerships

Advantages:

Again fairly easy to set up and can be tax efficient. Partnerships are not taxed as such but each partner has to account for their share of the partnership profits on their own self-assessment tax return. The share doesn’t have to be equal between all the partners but can be split in whatever proportion you wish, perhaps to take account of who does more work or who put most money up.

There is more paperwork required to set them up and though you can enter into a partnership without a written partnership agreement this is not recommended. You can buy “template” agreements in many shops or on the Internet I would strongly urge you to ask your accountant or solicitor to advise you. It may cost a little more but can save you a lot if things go wrong. If you haven’t yet got an accountant or solicitor drop me an email me and I’ll be happy to quote for drafting an agreement and possibly recommend an accountant.

Disadvantages

These are the same as for a Sole Trader with the added disadvantage that in law all partners are jointly and severally liable for the actions or errors of the others. So if your partner makes a mistake, or causes a customer loss in any way then you can be sued and loose your home and possessions even if you had nothing to do with what went wrong. Also a partnership in England or Wales cannot own assets in its own name only on behalf of its individual partners.

Limited Companies

Advantages

The main advantage is that a company is a separate legal entity – a corporate person – quite distinct from the owner or owners (shareholders) of the company. Therefore if the business goes fails and goes into liquidation the shareholders cannot be asked to pay the debts of the company.

However, you have to be warned that although the shareholders cannot be held liable for the company debts the directors can! Of course for many companies the shareholders and the directors are the same people. This isn’t something that happens all that often but it is happening more and more each year. The reason is that the directors must run the company in a proper manner; recording decisions correctly but most importantly they must not trade while the company is insolvent. What this means is that if you order some goods or services and the company cannot pay for them when required then you could end up paying yourself. This is really to stop directors ordering goods and not paying for them – they can’t just walk away from the debt.

Other advantages include the fact that it should be easier (and cheaper) to arrange liability insurances such as employer’s, public, product etc. and it gives better sstatus and credibility – quite simply a limited company presents a better image, and some businesses prefer to deal with companies.

Also shares can be sold so allowing you to pass ownership to who you wish, be that to new owners or around your family, or business partners. This also ensures continuity of the business in the event of your death.

A director who owns shares in the company can be partly paid by “dividend” (rather than just a salary) which attracts neither employers nor employees NIC liability. Finally, trading as a limited company is tax efficient for retained profits.

Disadvantages

More paperwork is required to comply with the requirements of the Companies Act. However, none of these problems are insurmountable and recent legislation has made a limited company a much more attractive way to run a business.

Directors’ are considered to be employees and must pay both PAYE and National Insurance Contributions (NIC). Payments made to directors’ also attract employers NIC liability. Payment of expenses is open to scrutiny and may lead to tax, NIC and VAT liability if not properly controlled and approved.

The company accounts have to be filed at Companies House and are therefore a matter of public record for anyone who cares to look. (However small companies can claim exemption from having to give more than very basic information.)

The proper management of a business conducted via a limited company will require more control and input from your accountant. This is likely to be on a quarterly or monthly basis. However, not only will such involvement save you money, it will also have other benefits as you should be alerted to problems by the provision of regular management accounts. Your bank and any potential lender or investor will be more impressed and helpful when they know your business is being run in a structured manner. Because they don’t have to keep tight control unincorporated businesses tend only to seek advice from an accountant when they are in trouble or when they seek finance. By that time it is often too late for an accountant to help them at a reasonable cost  – if at all. Prevention (of problems) is better (and cheaper) than the cure!

If you start as a company then you can’t change your mind easily because there are no provisions to enable disincorporation without a tax penalty.

Limited Liability Partnerships

Advantages

These are a sort of hybrid company/partnership. They have a corporate identity and unlike ordinary partnerships can own assets in the name of the LLP. Like ordinary partnerships they are tax transparent so the LLP does not pay tax itself but the partners, who unlike ordinary partnerships can be individual people, companies, or other LLPs must account for their own tax. This makes an LLP tax efficient where there are non UK resident partners who may be able to avoid UK tax and only pay tax at a lower rate elsewhere. For example in the Isle of Man the standard rate of corporate tax is zero percent and the standard rate of personal tax is just 10%.

Disadvantages

The company accounts have to be filed at Companies House and are therefore a matter of public record for anyone who cares to look. (However small partnerships can claim exemption from having to give more than very basic information.)

Common Concerns

No matter which structure you choose if you are likely to have a turnover in excess of £67,000 you will also have to register for VAT. Click here for more information.

Also, unless you are a sole trader or partnership you will need to register as an employer for PAYE and National Insurance even if the only employee is yourself. You can find details here.

Conclusion

No two businesses are the same and so each case must be considered on its merits. If in doubt, the safest course is to start trading as an unincorporated business, leaving the option of incorporation at a later date open.

This article is designed as a general introduction to what is a complex and personal matter of choice. It is my intention to gradually deal with specific questions regarding starting a business in future postings. However if you have any questions please do post a comment asking for further information and I’ll be pleased to post an answer.

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Category: Starting a Business

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