13 min read
So you have decided to take the plunge and start your own business. Congratulations! While you are obviously eager to get up and running with production and marketing, you will need to take care of some formalities first – specifically, what structure your business will follow.
Whether you set up as a sole trader, partnership or limited company, you must consider tax implications and various pros and cons. Sure, our accountants will give you more specific details. But for now, we will provide a quick introduction to each of these three business structures:
Sole trader
This is the simplest business structure and is exactly what it sounds like – you are the sole owner of your business. Around 60% of small businesses in the UK are registered as sole traders. You take all the business decisions and are personally responsible for all agreements you enter into.
In that sense, a sole trader structure occurs automatically the moment you decide to enter into business. In terms of tax, you file a Self Assessment tax return with HMRC every year with details of all your earnings and expenses.
You must also keep complete and accurate records of all your business transactions to avoid scrambling for paperwork during the tax season.
Pros of being a sole trader
- It is easy to get started, as there is not much paperwork when you are setting up. In fact, you just need to notify HMRC that you are self-employed, and you can start your business.
- You do not need to file your accounts with any public registry, which lets you maintain privacy.
- All profits after tax belong to the sole trader. You do not need to distribute them as dividends or retain them within the business unless desired.
- Unlike directors of limited companies, you have fewer statutory reporting obligations, which can save time and administrative effort.
Cons of being a sole trader
- Raising money from banks and financial institutions could be more challenging – they tend to prefer helping more formal structures.
- As a sole trader, you and the business are regarded as the same entity, meaning if you run into financial trouble, you will be liable for everything.
- Unlike employees with rights to redundancy payments and statutory sick pay, you must make your provisions in case you cannot work.
- You may end up paying a higher amount of tax on your profits.
Partnership
This is one of the oldest ways of doing business. Essentially, two or more people come together and decide to do business to make a profit jointly. All partners own all assets and liabilities and possess unlimited liability for debts.
Each partner pays income tax the same way as they would if they were sole traders. All partnerships are subject to the conditions laid down in the Partnership Act of 1890.
There are three types of partnerships you should know about:
General partnership
This is the most common form of partnership. While there is no necessity for formal registration or incorporation, a nominated partner typically manages tax returns, maintains business records, and liaises with HMRC. There is flexibility in management with the freedom to divide roles and responsibilities.
Pros of entering into a general partnership
- Running a partnership is much easier than running a limited company, as there are fewer rules and no formal registration requirements.
- Liability is distributed across partners based on how much each partner has invested in the business. So if you have invested 40%, you are only 40% responsible for any debts or other liabilities.
Cons of entering into a general partnership
- You are still personally liable for your share of liabilities, which could be a sizable amount.
- Without a proper partnership agreement, individuals could face friction with each other. You could even enter into a partnership without knowing the agreement, at which point the partnership laws might come as a shock. So even if it is not needed by law, drawing up a partnership agreement is always recommended.
Limited partnership (LP)
In a limited partnership, there are both general and limited partners, each having distinct roles and liability levels. General partners have unlimited liability and actively manage the business, while limited partners, contributing financially, only bear liability up to their initial investment. This structure necessitates registration at Companies House and HMRC, though the management and decision-making chiefly rest with the general partners.
Pros of entering into a limited partnership
- It offers a mix of liability protection. Meaning, limited partners have capped financial risk.
- It attracts investors (limited partners) without giving away management control.
- A partnership agreement is private, not mandatory.
Cons of entering into a limited partnership
- This involves more administrative requirements, including registration and ongoing filings.
- Limited partners cannot actively manage or withdraw their capital.
- There is potential for conflicts between general and limited partners.
Limited liability partnership (LLP)
LLP is a partnership model where all members enjoy limited liability, restricting their financial responsibility to their initial contributions. While all members can play a role in business decision-making, there are designated members with extra responsibilities like company account maintenance and dealings with HMRC. LLPs require formal registration at Companies House and have specific ongoing filing mandates.
Pros of entering into a limited liability partnership
- All partners enjoy limited liability.
- Partners pay tax based on their profit shares.
- An LLP is more structured, potentially attracting more sophisticated partners or investors.
- Designated members help streamline responsibilities, and equity is divided between equity members and fixed share members.
Cons of entering into a limited liability partnership
- There is a higher administrative burden with mandatory registrations and ongoing filings.
- Managing relationships between equity and fixed share members can get potentially complex.
- This relatively newer structure might be less familiar to some compared to the traditional partnership.
Limited company
A limited company has its legal structure separate from its directors and stakeholders. It is run according to a formal guidebook known as the Articles of Association, a copy of which needs to be submitted to Companies House for public access.
Shareholders typically own a limited company, and you are required by law to have at least one. Appointed company directors take day-to-day decisions – shareholder approval is only called upon in special cases.
The key distinguishing feature of a limited company is that it is treated as a separate legal person and can enter into agreements in its name. The company’s assets are not the directors’ assets, and vice versa.
Every company must pay corporation tax and submit annual accounts to HMRC and Companies House at the end of the year.
Pros of having a limited company
- A company is its legal entity, which means that the directors of a company have limited liability. If the company becomes insolvent, the director’s personal assets will not be called upon to pay it off.
- As a company owner, you can appoint yourself a director and pay yourself dividends if the company is profitable, which comes with a preferential tax rate.
- A limited company might offer better tax efficiency than a sole proprietorship. Directors of limited companies are subject to a primary corporate tax rate of 19%, while sole traders face multiple tax categories with varying rates. As annual profits rise, so does the tax liability for the sole trader.
Cons of having a limited company
- Setting up and running a limited company is more complicated than the other two types of business and typically calls for the help of a specialist.
- Companies need to file various documents with Companies House and could incur heavy penalties if they fail to do so.
There are two types of limited companies you should know about:
Private Limited Company (LTD)
A private limited company has shareholders and a board of directors. Shareholders do not directly run the company; they elect directors. They must issue a statement of capital detailing shares, their value, and shareholder information. Shares are traded privately. To establish a limited company, one must register with Companies House. Upon successful registration, the company will receive a Certificate of Incorporation.
Pros of entering into a private limited company
- Directors are responsible for the day-to-day running of the company.
- While a single individual can be both the sole director and sole shareholder, there is no limit to the number of shareholders an LTD can have.
- Shareholders have limited liability. This means they are only liable for the company’s debts up to the amount they have invested or agreed to contribute.
- Shares can be used to raise capital privately.
Cons of entering into a private limited company
- Annual filings with Companies House and the need to maintain proper accounting records can get tedious.
- Shareholders cannot trade shares publicly, limiting liquidity.
Public Limited Company (PLC)
A public limited company can trade its shares on a stock exchange. The minimum issued share capital value is £50,000, with at least a quarter sold before registration. It requires at least two shareholders, two directors, and a company secretary with an ICSA qualification. Such companies must also hold an Annual General Meeting (AGM).
Pros of entering into a public limited company
- The ability to sell shares on stock exchanges offers significant capital-raising opportunities for a PLC.
Shareholders enjoy limited liability. - Easy ownership transfer is possible through the trading of shares.
Cons of entering into a public limited company
- It has a higher regulatory burden and is subject to market pressures.
- A PLC requires a qualified company secretary, adding to operational costs.
- It is obliged to disclose more information publicly than an LTD, potentially exposing business strategies to competitors.
Over to you
In conclusion, these three business structures have advantages and disadvantages, so choosing one requires careful consideration. The good news is you can change your business structure later if the industry demands it or if you feel a different one will serve you better.
As always, Golding Accountancy can guide you through the setup and transition process and make sure you stay within the letter of the law. We are experienced in managing the financial affairs of sole traders, partnerships, and limited companies.
You will never miss a crucial deadline with our automatic monthly compliance reminders. Enjoy the benefits of our state-of-the-art cloud-based software that simplifies account management.
Our team is always at hand whenever concerns arise, offering free and unlimited email and telephone support. Furthermore, our payroll support ensures your business operations run seamlessly and efficiently. Contact us today.
