Starting a business is always exciting, but the legal structure of your business will have a significant impact on how you operate in the long-term. It is important to understand the different types of legal structures available in the UK and why choosing the right one matters.
Sole trader
For those just starting out or wanting to keep things small, being a sole trader might be the attractive option. Not only does it avoid responsibility for such things such as filing annual accounts, but it’s also easily set up and less expensive than other structures. As with all legal arrangements however there is still risk involved if something goes wrong.
Pros and cons of sole trading
As a sole trader, you are the business. You can start trading immediately after registering for self-assessment with HMRC and there is no requirement to file accounts or other forms such as those required by Limited Companies at Companies House. As such, a sole trader can avoid additional accounting fees.
However, there can be disadvantages to operating as a sole trader. As the sole owner of your business, you are personally vulnerable if your business were to be sued or become bankrupt. All assets may be accessible to creditors in order for them to reclaim debt, including any personal assets which may have been used when starting up the business (e.g. car and/or property).
Partnership
A partnership involves joint ownership of the business by at least two people who share profits and losses equally; however, it also carries with it unlimited liability in the event of any losses incurred. If this level of risk is too high an alternative structure for a partnership might be a Limited Liability Partnership (LLP).
If, for example, two people take on high risk investments, a Limited Liability Partnership (LLP) would limit each partner’s liability to only their own investment should anything go wrong.
The pros and cons of a business partnership
This form of ownership can be beneficial for businesses, as it allows for the sharing of resources among partners and enables each partner to bring unique skills and knowledge to the business.
However, there are also drawbacks associated with choosing a partnership. Such a business structure requires strong interpersonal relationships between partners as well as well-defined roles each partner will play. Additionally, if there is disagreement between partners on how decisions are made, this could have serious ramifications for the future of the business. The balance of work and reward should be defined from the start, ideally set out in a contractual arrangement. This could avoid problems surfacing over the long term.
Private Limited company
A private limited company is a separate entity from the owners and is owned by shareholders. Crucially the owners are only liable for their own losses up to the amount they invested in shares. This protects the private assets of the owners should the business fall in to debt or be declared bankrupt.
The pros and cons of a private limited company
This type of business structure provides advantages and disadvantages depending on the needs of the owners. It creates limited liability, meaning shareholders are not liable personally for any debts or losses incurred, and it offers tax savings in the form of corporate income tax. A private limited company will have access to loans and grants a sole trader may not have and a greater potential to raise funds from private investors and venture capitalists.
The negatives may include more bureaucracy when forming and managing the business, more filing requirements such as annual accounts with Companies House and the HMRC. There is also the requirement to meet legislation as the company grows and the costs that might incur. For instance, health and safety legislation if the company grows to over 5 employees.
And finally…
Having a clear contractual arrangement setting out the requirements and rewards in terms of what you put in and get out of the business should be a priority. This starts with deciding which legal structure will best suit that business, depending on its size, purpose and owners. Choosing the right structure for your new business is not just about the level of financial risk and bureaucratic responsibility but the relationship you form with those you may choose to go in to business with. The level of contribution, whether in terms of finance, time and skill level and the compensation each receive, all matter when setting up a business.