Choosing a business structure

The way in which your business grows, pays tax, takes big decisions and deals with liabilities will depend on its legal structure. This is something you decide at the outset, but can change later on if it becomes desirable.

The four most popular structures are sole trader, partnership, limited company (Ltd) and limited liability partnership (LLP). All have advantages and disadvantages, depending on factors such as the size of your business, the nature of your business and your future plans for it.

Here is a quick summary of each type of business structure.

Sole trader

This is the most popular structure for a startup, being the simplest. There are no fees to register, very little red tape, and as a sole trader you are in full control of business decisions. You also get to keep all the profits from the business, after tax. You can employ staff, so long as you inform HMRC and follow employment law.

The main drawback is that your business and personal finances are not legally separate. This means that, if the business has debts or is sued, any liability can be met from your personal wealth. This exposes you to more personal risk than other business structures, so may not be suitable for a high-cost startup.

As a sole trader you pay income tax on your profits (rather than corporation tax). This means that any profits above £45,001 will be taxed at 40 per cent, and profits above £150,000 will be taxed at 45 per cent. Depending on your profits, you may also have to pay National Insurance (NI) contributions.

Summary: A simple and agile structure, but with a lot of personal risk.

Partnership

A partnership is similar to the sole trader structure, except that there are at least two of you. There is no legal upper limit to the number of partners, though very large partnerships can be riskier to manage (see Limited Liability Partnerships below). Partners sign a partnership agreement to establish how the business’s ownership, profits and liabilities are shared between them, and how partners may leave the partnership. Each partner registers as self-employed and submits a separate tax return. Your tax and NI obligations are similar to those of a sole trader.

The advantages of this structure are flexibility and simplicity, with the added bonus of having more owners to run the business. The main disadvantage is that all partners are jointly responsible for all the business debts. This means for instance that if one partner is sued successfully, all partners must share the damages.

Summary: A streamlined setup for business partners who know and trust each other well.

Limited company

Incorporating your business as a limited company requires you to register it at Companies House. One big advantage of doing so is that this creates a separate legal entity – your company – with finances that are separate from yours. This reduces your personal exposure to financial risk, so if the business fails (or is sued) then you are liable only for the face value of your share in the business.

The other main advantage of a limited company is the tax regime: companies pay corporation tax at 19 per cent on their profits. This can be significantly more tax-efficient than paying income tax on income, especially for higher-rate taxpayers (though as a director you will still have to find a way to take income from the company, such as salary or dividends, which will be taxed accordingly).

On the downside, a limited company involves much more administration. You are likely to need a company secretary and very probably an accountant too (though you can outsource both of these roles). You must submit an annual company tax return and full statutory accounts to HMRC, and are responsible for paying employees’ income tax and NI contributions too.

Summary: Good for the maturing business that is ready to trade agility for greater stability.

Limited liability partnership

A limited liability partnership (LLP) is a popular structure for professional services such as accountancy and legal firms. In most respects they are similar to ordinary partnerships (see above) but as the name implies they have limited liability (like a limited company). An LLP must be registered at Companies House, and at least two partners must be ‘designated members’ who take responsibility for filing the annual accounts.

As with an ordinary partnership, each partner registers as self-employed and submits a separate tax return. But if the business fails, each partner is only liable for the face value of his or her share. The administrative burden is similar to that of a limited company, so an accountant and company secretary may be desirable (though not required by law).

Summary: A sensible step for partnerships above a certain size.

Ask your accountant about the most suitable structure for your business at its current stage of development.

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