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Structuring for success
As a new business choosing a business structure you more often than not face a four-way crossroad:
- Become a sole trader
- Form a partnership
- Incorporate a limited liability company
- Limited Liability Partnership (LLP)
Ultimately it is about deciding which best suits you.
There are other options available, but these four structures offer the most tried and tested routes. Starting out with the simplest structure is usually the best option as you can easily change to a more sophisticated model as your business scales up.
This can suit many small start-ups in the early stages. As the sole proprietor you are responsible for all the decisions, responsibilities and profits for your business. This carries with it both advantages and disadvantages. At the outset there are minimal forms to fill in, no fees to register and you can start trading straight away. Only a small amount of capital is needed and you keep 100% of post tax profits – tax on income and expenses are included on your personal income tax form.
The disadvantage to operating as a sole trader is that you are personally liable for any debts. The law makes no distinction between the business and its owner, meaning business debt can be recovered from the owner’s personal wealth and assets if the business fails.
Although a sole trader can employ staff we usually recommend a limited company or LLP in this situation. If there are no employees then the business will rely entirely on you and your good health.
As your business grows, further problems can emerge as profits are taxed as income. Given the current tax bands, as soon as you top £42,385 a 40% tax rate will be incurred and 45% above £150,000. In addition sole traders pay class 4 national insurance on a sliding scale based on profits.
A partnership is a business owned by two or more people. Ultimately the structure is similar to that of a sole trader with responsibility split between the partners. For every partnership a clear agreement will need to be drawn up to outline the responsibilities, capital investment and profit allocation for each partner, how disputes are resolved and what happens if a partner leaves the business.
The advantage of a partnership is that the workload and day-to-day running of the business is shared. If you fall ill or need a holiday, others could be relied upon to take the strain.
As with a sole trader structure, a partnership has unlimited liability with all partners taking responsibility for any business debts. Each partner will be registered as self employed and will need to submit a separate tax return.
Partnerships should only be entered into with people that you know well and trust as disputes can have a negative effect on the business.
Incorporating a Limited Liability company (Ltd)
A limited company has its own legal identity and is registered at Companies House. Ownership is usually divided into shares which people own, making them shareholders. The company is run by directors who may also be shareholders.
The major advantage of a limited company is that the owners are not personally liable in most circumstances. Limited companies pay corporation tax rather than income tax on profits as a sole trader or partnership would. For many companies the rate of corporation tax is 20% so if profits exceed £42,385 and surplus profits are kept in the company there is a tax saving compared to sole traders and partnerships.
Profits after tax can be distributed to the shareholders by dividends. Companies do not pay national insurance on profits, nor do shareholders on dividends.
Incorporation adds credibility to a business and it is important to be aware that if you are intending to gain sub-contracted work for larger companies, you may need to incorporate to satisfy their guidelines.
Due to the limited liability status of the business, banks may require guarantees on lending. There will inevitably be more form-filling to meet regulations and higher professional fees will be incurred due to structure and statutory legal requirements. Each year, a full set of accounts and a tax return need to be filed with HMRC and Companies House. You also have to make monthly or quarterly payments of employee income tax (PAYE) and National Insurance Contributions (NICs).
Limited Liability Partnership (LLP)
A limited liability partnership combines elements of a partnership and limited company. It offers the flexibility and tax regime available to partnerships, as well as the limited liability available to limited company shareholders. The number of partners is not limited, however, at least two must be ‘designated members’ responsible for filing annual accounts.
As with a partnership, each member has to be registered with HMRC as self-employed. LLPs also have to be registered at Companies House and have a members agreement that states the share of the profit each member will receive, as well as other aspects of the structure and procedures.
There are complex legal requirements involved with an LLP and consultation with a professional is strongly advised before choosing this structure.
Historically LLPs have been well suited to the professional service sector so are particularly good for companies hoping to grow by attracting other professionals to join the business.
If you would like further guidance or advice on structuring your business, contact Adrian Le Roux.