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Choosing the Right Business Structure

What is the best legal structure for your business?

23 June 2016 | Starting Up

Choosing a Business Legal Structure

If you are planning a new business, the legal structure is something you will need to consider very early on, and ideally before starting to trade. Selecting the right business structure is an important decision that can have significant tax and commercial implications.

The vast majority of small businesses in the UK are one of three types of business structure – sole trader, partnership, or limited company. We explain the differences as well as the advantages and disadvantages of each, and briefly cover alternative business structures.

The appropriate business structure for you may be obvious, but should you have any uncertainties it would be wise to consult a professional adviser such as accountant or lawyer. Making the wrong choice now can lead to more costs including both extra tax and professional fees to change to an alternative structure later on.

Sole Trader

BLI SoleTraderA sole trader simply operates their business as an individual. Over 60% of businesses in the UK are sole traders.

Profits from a sole trader business are declared in your self-assessment tax return each year, together with any employment income. You and your business are considered one and the same.

The tax system in the UK generally favours limited companies over sole traders, however any tax savings may be used up with the associated costs of running a company. Operating as a sole trader is the cheapest option as there are no set up costs, and a limited company has to prepare accounts and tax returns each year.

If the business is a part-time enterprise, perhaps a sideline to make a little extra on top of your regular job, then operating as a sole trader may be best. If you will be starting on a part-time basis, but expect to give up your employment to make this your full-time occupation, you should consider if a limited company may be appropriate.

Pros & Cons – Sole Traders

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No setup costs

R

Start trading immediately

R

Cheaper accounting and administration costs than other options

R

Completely private – no information is required to be publicly available

Q

Personal liability for the business’s debts and obligations

Q

May be more difficult to borrow money

Q

After-tax income may be less than using a limited company

Q

May look less credible to customers or suppliers

Partnership

BLI BakeryPartnershipWhere there is more than one owner of the business, you may trade as a  partnership.

This is similar to being a sole trader, only that there are two or more partners. Each partner’s respective share of the business profits is considered their own income, and is declared in their self-assessment tax return.

Like a sole trader, a partnership’s debts are the personal responsibility of each of the partners. Crucially, this is “joint and several liability” which means each partner is responsible for all of the debts, not just their own percentage share.

There is no requirement to register a partnership. If the partners are not a couple, it is wise to have a written partnership agreement setting out important issues such as profit sharing and responsibilities, and professional advice is recommended.

Pros & Cons – Partnership

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Tax efficiency for partners who are married or domestic partners

R

No business registration is required to set up

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Privacy – no information publicly available

Q

Personal liability for the business’s debts and obligations

Q

May be more difficult to borrow money

Q

After-tax income may be less than using a limited company

Q

May look less credible to customers or suppliers

Limited Company

A private limited company is a legal entity which must be registered with Companies House.

The company is considered a separate legal person from its shareholders, and can borrow money, trade, sue and be sued, independently from the owners. A company must pay Corporation Tax on its net profits after paying business expenses including salaries.

The liability of shareholders is limited to their investment in the company. This means that personal property is not directly at risk if the company is in financial trouble and cannot pay its debts.

If you will be employing staff a limited company is usually a better option, and using a company to run your business can add credibility to outsiders such as suppliers and some banks and other lenders.

Pros & Cons – Limited Companies

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Liability – owners are not personally responsible for debts

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Separation of personal and business affairs

R

Tax benefits

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Credibility to customers, suppliers, and others

R

Improves borrowing ability

Q

Public disclosure of some accounts information, shareholders, and directors

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Increased costs of accounting administration

Q

Directors duties and legal responsibilities

Other business structures

Although sole traders, partnerships, and limited companies are the most common business structures for small businesses, there are some other options which are appropriate in particular circumstances.

Limited Liability Partnership (LLP)

Like limited companies, LLPs are registered with Companies House. They are usually appropriate only for professional partnerships such as lawyers, accountants, architects, or similar practices who need flexibility in profit sharing, as well as some legal protection similar to limited companies. They are usually more expensive to administer than limited companies.

Public Limited Company (PLC)

PLCs work in a similar way to limited companies, but are designed for selling shares to the public to raise money. As a result they have more qualifying requirements than a private limited company to be registered, and a much higher legal and administrative burden. They are therefore a more costly option, and one usually appropriate to companies intending to be listed on a stock exchange.

Co-operative

Co-operatives are owned and run by their members, who have an equal say in decisions. Common types of co-operatives are building societies, farmer’s co-operatives, and community shops, but in theory any enterprise can be a co-operative. Its major feature is shared control by all members, rather than control by a small group of individuals.

See the Co-operatives UK website for more in-depth information on this form of business structure.

Company Limited by Guarantee (LBG) & Community Interest Company (CIC)

These are usually suitable for community organisations, clubs and societies, charities (LBG only), and other non-profit organisations.

Click to view our selection of the best Company Formation Agents for UK startups and small businesses.

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