While it may seem like a formality, choosing a legal structure for your business is actually one of the most important decisions that you will make as an entrepreneur. This is because the way your business is structured will affect future growth and development opportunities.
Not only does the choice of legal structure impact the ways that your business can raise money, for example, it also has a bearing on fundamentals such as taxation, record-keeping requirements, the way management decisions are made, and how you can take money out of the business for personal use.
The big four
The four most commonly adopted legal structures in the UK are:
• Sole trader. This describes any business that is owned and controlled by one person, although sole traders may employ workers. Hairdressers for example, frequently set up as sole traders.
• Partnership. These are businesses owned by two or more people and this is in many ways an extension of the sole trader model. Dentists, accountants and solicitors frequently form partnerships, as do husband and wife, or family teams.
• Limited liability company (LLC). A limited company allows an entrepreneur to keep their own assets and finances separate from the business itself. The most common type of LLC is the private limited company (Ltd), however public limited companies (PLCs) also exist.
• Limited liability partnership (LLP). Introduced in April 2001, the LLP is the UK's newest business vehicle. It is a hybrid between a traditional partnership and a LLC.
Deciding what's right for you
To decide which structure is right for your business, it's important to look at the advantages and disadvantages. The following table provides a summary:
| Legal structure | Advantages | Disadvantages |
|---|---|---|
| Sole trader | • Easy and inexpensive to set up – there are no registration fees. | |
| • Administration is minimal. For example, annual accounts do not have to be filed with Companies House, although they will be required to accompany your self-assessment tax return. | • Your profits are taxed as income by HMRC, as you are self-employed. | |
| • You are in control and can make decisions quickly. This includes how daily operations are run, and how you choose to grow the business. | • Initially, this may not cause a problem, but once your profits grow to more than £34,370 (2012-13 tax year), you will be taxed at 40%. For profits over £150,000, income tax will be 50%. | |
| • You can keep all of the profits (after you’ve paid tax on them). | • As owner of the business, you alone hold responsibility for the liabilities and risks of the business. This ‘unlimited liability’ means that any business debt can be settled from your personal wealth, should the business fail. | |
| • Despite being a sole trader, you are allowed to employ staff. | • Sole traders often work long hours and have no-one to share the burden of running their business with. | |
| Partnership | • The business responsibilities are shared between partners. This means that there is more scope for consultation on business decisions and support when one person is ill or away on holiday, for example. | • Shared responsibility can lead to disputes. Difficulties may arise over making unanimous business decisions, or perhaps the distribution of profits. A deed of partnership or partnership agreement should assist with he latter, but will not necessarily stop disputes over effort put in to the business, for example. |
| • More than one person will be contributing capital to the business, allowing for greater flexibility and increased potential for growth. | • Financial responsibilities are shared, too. So partnerships are subject to unlimited liability, meaning each partner is personally responsible for all of the debts the business has incurred. | |
| • Partnerships generally involve less administration and red tape than LLCs or LLPs. Both partners will need to be registered as self-employed and fill in self-assessment tax returns, however. | • Partnerships can be difficult to wind-up, especially where there are disagreements. | |
| Limited liability company | • Offers improved financial security compared to sole trader or partnership arrangements, where the company is owned by its shareholders and limited by shares. This means that shareholders are only liable for any debt the company accrues according to the levels of their own investment. | • Registration with Companies House is required. This involves ongoing administration, as full accounts and an annual return will need to be submitted. These are made public. |
| • More favourable tax regime. Limited companies pay corporation tax on their profits. At the time of writing, the UK small profits corporation tax rate, applied up to £300,000, is 20% and only rises to 24% once profits exceed £1.5m (there is a sliding scale in between). | • HMRC will also require full statutory accounts and a tax return for the company each year. This can be time consuming and will incur accountancy fees. | |
| • LLC status can make it easier to borrow money and allows the business to be perceived externally as more credible, opening up the potential customer base. | • The profit the company makes has to be distributed. As a company director, you will take a salary out of the company’s profit and pay income tax on it. | |
| • Sometimes disputes will arise between directors and shareholders. This can make management feel disempowered. Also, where shares are sold to raise funds, the management’s power can become diluted, or a takeover bid may be launched. | ||
| Limited liability partnership | • Provides the benefits of a limited liability company (outlined above), while allowing you the flexibility to adopt any internal structure, just like a traditional partnership. | • Like a LLC, disclosure requirements mean that LLPs must file annual accounts and annual returns. |
| • Your profits are taxed as income, like a traditional partnership. |
What's in a name?
The type of legal structure that you set up will have some impact on your business name. For example, although sole traders and partnerships won't need to register their business name (assuming they choose not to trade under their own name), it must comply with Business Names legislation. And if you trade as a sole trader under a name other than your own personal name(s), you must put your own name on your stationery, any company documents and at your premises.
You must also ensure your business name isn't already in use. There are a number of places where you can check existing business names for free: the Companies House register, which lists the names of limited companies and LLPs; the Trade Marks Journal published by UK Intellectual Property Office (UK-IPO); trade and telephone directories; membership directories for chambers of commerce or professional bodies. You could also check online to see if a business has already registered an identical domain name.
LLC and LLP names must be registered at Companies House and comply with the Companies Act legislation. This will be their 'registered name', but they may also adopt a 'business name' that complies with the Business Names Act.
Making a choice: first steps
Because choosing a legal structure will have a lasting impact on your business, it is incredibly important to seek proper help and expertise before making your decision. Useful online resources for finding an accountant or solicitor include the ICAEW directory of chartered accountants (www.icaewfirms.co.uk/business/index.php) and The Law Society's equivalent directory (http://www.lawsociety.org.uk/find-a-solicitor/).
If you are looking to do more of your own research first, local libraries often have useful resources, and www.gov.uk offers a range of facts and advice for entrepreneurs. Likewise, the Lloyds TSB Commercial Business Help pages (http://businesshelp.lloydstsbbusiness.com/starting/) provide up-to-date, trusted guidance for start-ups – and our local business managers are also on hand for expert support.
Finally, as your business grows, your requirements will change. From time to time a professional review should be conducted to ensure that your business has the best possible legal structure in place.
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• This article was amended on 4 January 2013. The original said that a PLC was a private limited company. A PLC is in fact an abbreviation for public limited company.
