Choosing the Right Business Structure for Your Company
Many thousands of budding entrepreneurs start up new businesses each year. Many of them go on to become very successful and continue to grow from strength to strength, but one thing is true of all of them – they all had to start somewhere and the successful ones needed to have a strong foundation from which to grow.
Knowing which business structure to set up for your business is crucial if you are going to establish your business and grow from a strong foundation. Here we will take a look at the different business structures that are open to you and the pros and cons of each one. Whether you were thinking of setting up as a sole trader, a partnership or a registered limited company, it is important that you make the right choice from day one of your new business.
The four main business structures
For most new start-ups there are usually four main business structures to choose from.
- Sole trader
- Limited Liability Company
- Limited Liability Partnership (LLP)
The four business structures listed above are the most popular choices for the majority of new business owners. However, there are other business structures available such as not-for-profit community interest companies and charity organisations, but for most of our readers, the above four choices are where we are going to focus our interest.
Sole trader business structure
One of the most common business structures to set up in the early days of a new business is going it alone as a self-employed sole trader. There are currently hundreds of thousands of sole traders registered with HMRC. If you have a fantastic business idea that you can start up all by yourself, it is easy to register online as a sole trader with HMRC to get your business off the ground.
Setting up as a sole trader is quite possibly the easiest route to starting a business because you don’t need a huge amount of money to invest in your business. Quite often a sole trader will be a self-employed person with some sort of skill that they can sell or hire out to others. Sole traders vary greatly, so can be anything from a creative crafter, artist or designer making and selling their own wares, or a highly knowledgeable professional working as a freelance business consultant or accountant etc. There are also thousands of sole traders working as independent hairdressers, beauty therapists, personal trainers, lifestyles gurus, photographers, writers, web designers and more.
While the name ‘sole-trader’ implies that you are some sort of one-person setup, you can actually employ staff if your business needs an extra pair of hands. However, there are certain rules to follow around employing staff as a sole trader that you need to adhere to.
If you are starting to tinker with a business idea in your spare time, then depending on how much money your side business creates will determine whether you should register your business with HMRC. You need to set up as a sole trader if any of the following apply:
- you earned more than £1,000 from self-employment between 6 April 2017 and 5 April 2018
- you need to prove you’re self-employed, for example, to claim Tax-Free Childcare
- you want to make voluntary Class 2 National Insurance payments to help you qualify for benefits
Once you have set yourself up as self-employed you will be registered for Self Assessment and will need to file a tax return every year to HMRC.
As a sole trader, all business decisions are your own. This can be a benefit because you will not need to run your business decisions by any board members or shareholders that may not be receptive to your ideas and business decisions. You also get to keep all of the profit your business makes after tax has been deducted.
The disadvantages of being a sole trader
The one major downside of becoming a sole trader is that the law makes no clear distinction between you and your business. This means that you will be personally liable for everything that happens in your business name. Should your business fail, you will be fully responsible for paying off any outstanding debts that have been run up in your business name. This means that you will be putting your personal assets at risk, such as your home, car and personal money in your bank account.
Another disadvantage to consider is that should you decide to give up your business, the business will not continue to operate in your absence. This is also the case should you decide to retire or if you die.
You should also consider your tax position. As a sole trader your profits will be taxed as income, so once your earnings start increasing you will end up crossing a tax threshold that will see you paying 40% tax once you reach £41,865 and then 45% tax above £150,000.
A vast majority of sole traders will eventually go on to grow their one-person business into something larger. As their business grows, the need to take on employees or a business partner (or a number of partners) will become a crucial next step in developing their business. At this point, most sole traders will look at stepping up their business and upgrade to form a limited company or a limited liability partnership.
Forming a regular partnership
A regular partnership is run in much the same way as being a sole-trader, but working with a person or people that you know well. Many partnerships are created among family member that want to work together to build a family business. This can work well in the beginning, but if you want to develop your business and go after big contracts, most larger companies that you approach will usually only look to work with incorporated partnerships (LLPs), so this is something to bear in mind.
Regular partnerships are often a natural progression from a sole trader set up. This can often occur when a husband and wife or two or more siblings decide to join forces to support their family member. The great thing about setting up a partnership is knowing you have someone that you trust who has got your back. Should you be ill or have an accident that means you cannot work for a while, you will have someone to pick up the slack and keep things going in your absence.
The only legal requirement of setting up a regular partnership is the same as with a sole-trader – as in each partner registers as self-employed with HMRC and will submit an individual tax return each year.
As standard business partners, you will each be responsible for the debts owned by your business should it fail, just as sole-traders are. This is why it is very important that you completely trust anyone that you are planning to go into business with.
Limited Liability Partnership (LLP)
A safer route to setting up a business partnership would be to go down the Limited Liability Partnership route. You can take your partnership and incorporate it by going through the company formations process. This means that your partnership will be registered with Companies House as an official LLP, and you will benefit from all the legal protection that comes with it.
Registering as an LLP will give your business great credibility in the business world, and will enable you to approach and work with larger companies that will only work with officially registered businesses.
Being an LLP can also make it much easier for you to source business financing, should you need it. This can help if you have plans to expand your business and move to larger premises, take on employees or upgrade your essential company assets, such as tools and machinery.
Disadvantages of forming an LLP
By registering your partnership with Companies House, you will be letting yourself in for a lot more paperwork. You will have statutory mail coming from both HMRC and Companies House that you cannot afford to ignore or incorrectly complete. There are also harsh financial penalties attached to late submissions or errors in your submissions.
In these cases, it would be wise to employ the services of an accountant that is used to handling business accounts and dealing with HMRC and Companies House.
Limited Liability Company formation
By far the most common business structure after a sole-trader is the limited liability company structure. Most limited companies are limited by shared and owned by their own directors and shareholders. You can register your company as a solo operator and be the company director as well as a company shareholder.
The biggest benefit to setting up a limited company is the fact that should your business fail, the most your shareholders will have to pay out is the face value of the shares they own in your business. This means that you can protect yourself from financial risk because there is a distinct line between your own personal money and the finances of the company.
Because a limited company has a separate legal identity in its own right, it will be your business that shoulders the financial liability and debt should the business fail. This means that your own personal assets such as your home, car and personal finances are all protected.
Tax considerations of an LLC
If you are looking for more favourable tax conditions for your business, then forming a limited company will also bring you tax benefits that cannot be enjoyed as a sole-trader or as a standard partnership.
Registered limited companies will pay corporation tax on their business profits and you as the company director will be taxed as an employee of the company, this means that you will only pay tax on what your company pays you for your salary. Currently, corporation tax rates stand at 19% with a government commitment to lowering the rate to 17% by 2020.
The downside of forming an LLC
There are more statutory responsibilities that come with forming a limited company, these include submitting full statutory accounts and a company tax return to HMRC each year. You will also be required to make monthly or quarterly payments of employees’ income tax (PAYE) and NICs. Companies House will also require you to file your statutory accounts and confirmation statement each year.
As you can see, there are more benefits to registering your company with Companies House than remaining as a sole trader. If you want to protect your personal assets, then it makes sense to reduce the risk of losing them by taking your business down the limited liability route.