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If you’re setting up a business in the UK, you can choose from a number of different business structures depending on the type and scope of the project.
In this article, we present all relevant business structures and give tips regarding the best choices for tradespeople, small businesses, and freelancers.
- Choosing the right business structure for your company
- Which business structures exist?
- Sole trader
- Limited company (Ltd.)
- Is it possible to change my business structure later?
Choosing the right business structure for your company
One of the most important choices you will make when starting up your new business is to decide which legal structure it should have. As a business owner, you have the option of quite a few structures including sole trader, partnership, private limited company, and limited liability partnership (LLP). The entity you settle on depends on several factors such as liability, taxation, and record keeping. It’s important to do thorough research so you choose the right one, since your choice can greatly affect the way you run your company: from affecting liability and taxes, to the control over the company. Our explanations of the different structures will help you find the structure that fulfils your organisational and personal financial goals.
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Which business structures exist?
There are many different business structures, but the majority of them fall into one of these three legal forms:
- Sole trader
- Limited company
We will go into more detail with each of these structures, but bear in mind that there is no right or wrong answer, just choose which option is most beneficial for your business.
Also known as a “sole proprietorship”, this is the simplest business structure and the most popular. It’s quick and easy to set up and doesn’t cost as much compared to other structures. All you need is an individual, who then needs to register their trade name in order to get a business license. You can use your own name or use a fictitious one. Be aware that making one up will not allow you to separate yourself from the company, since the business and business owner are seen as one entity by law. This individual is able to make all the decisions and have total control over what happens to the company as well as keeping the profits. Many businesses start with a sole trader business structure and expand and change their business structure as they outgrow it.
You need to set up as a sole trader if you earned more than £1,000 from self-employment between 6 April 2017 and 5 April 2018.
Many expenses, such as business travel and costs for premises, are tax-deductible. You will have to register for self-assessment with HMRC and fill in a tax return every year, but that’s more or less it when it comes to the paperwork.
You can be penalised if you fail to register your business before the 5th of October of your business’ second tax year.
A downside to this kind of business structure is that liability is unlimited, meaning that the individual also receives any debts the company may incur and this could affect their personal assets.
If the business owner dies, it’s very unlikely that the business will continue, since the owner is self-employed and tax is therefore self-assessed. Another disadvantage is that since profits are taxed as income, you will end up paying 40% as soon as profits reach £46,350 and 45% if they reach £150,000, which is extremely high.
Advantages and disadvantages of a sole trader structure
Advantages of a sole trader structure
Disadvantages of a sole trader structure
Easy to form
Pay more tax
Least expensive to set up
Lacks credibility in market
Not a separate business entity
Very little red tape
Business is terminated if owner dies
Owner is sole recipient of profits
Unlimited personal liability
Why should you choose a sole trader structure?
The sole trader business structure might be for you if your start-up is low-cost and you don’t plan to take out any loans. Be aware though that as a sole trader, you are solely responsible for any debts the business incurs.
Being your own boss can sound great since you can decide which direction the company should go in, but this does leave you vulnerable because you are liable for debts and any future liabilities. If someone sues you, it could lead to bankruptcy. You should ask yourself if it’s worth the risk.
A partnership is an extension of the sole trader structure and makes sense if you know the other person(s) well and trust them. This kind of business structure is similar to a sole trader structure in that it’s just as flexible. It has the added bonus of being managed by at least two people, which helps if one person is ill or wants to take time off. Shared responsibility takes pressure off the business owners.
You need to come up with a business name and have a “nominated partner” who is responsible for managing the partnership’s tax returns and record keeping. Each partner must be registered as self-employed with HMRC and file their own tax return. If your profits are over £6,205 a year, you will have to pay Class 2 National Insurance contributions (NIC), and over £8,424 a year means Class 4.
You have to decide how you plan to split the liabilities, ownership, and profits. This can be done in the form of a “partnership agreement”, which lists:
- The names of all partners
- An outline of the business
- The investment, liability, and profit share of each partner
- What happens if the partnership is dissolved
All partners are responsible for any debt the business occurs, which is why it is of utmost importance to choose the right business partner. Even if your partner is responsible for the debt, it lies on both your shoulders. A partnership like this is unlimited, just like the sole trader structure.
If a partnership has no specified duration, it can be dissolved at any time, which no doubt leaves the remaining partners with an insecure and unstable feeling. The whole partnership may end if one person opts out, especially if the remaining partners disagree on the next step.
A partner doesn’t necessarily have to be an actual person. For example, a limited company (explained below), counts as a “legal person” and can be thought of as a partner.
Advantages and disadvantages of a partnership
Advantages of a partnership
Disadvantages of a partnership
Allows for a division of labour
Not a separate entity
Easy and inexpensive to set up
All owners liable even if partners incur debt
Can be dissolved at any time: insecure
Why should you choose a partnership structure?
A partnership is a good choice if you want a structure that is easy and inexpensive to form. If you need financial help at any point, you’re more likely to receive it for a partnership than a sole trader since banks favour structures with more owners as they appear more trustworthy and stable. If you don’t want all the responsibility to fall on your shoulders, partnerships relieve you of this since you can share the tasks and decision-making.
Another type of partnership: Limited liability partnership (LLP)
If you want to form a partnership, but don’t want to be responsible for any debts any of the partners incur for the company, there is a way around it. You could consider a form of partnership known as limited liability partnership. With this kind of business structure, the members’ assets are protected. Your liability is limited to the amount you have invested in the business. Just like with a partnership, each member must register as self-employed with HMRC. There must also be an agreement, which defines what share of the profit each person should receive.
Limited company (Ltd.)
A limited company is very different to the two business structures mentioned above because this business is regarded as a separate entity to the business owner. The business is seen as its own “legal person” in the eyes of the law. A limited company offers limited liability, meaning that you’re not responsible for business losses or debt.
The limited company structure is most popular among small to medium-sized businesses. Many clients prefer to work with this structure as opposed to the sole trader structure or partnership structure.
A limited company is owned and controlled by those who own the shares in the company. It’s possible to keep all the shares if you want to run the business alone, but want a more secure structure. This is actually one of the most effective ways of working regarding tax. Be prepared, though, that more paperwork is involved than with the other business structures.
Limited companies are only taxed on their profits (the rate is usually around 20%), meaning that they avoid the higher tax rates of sole traders or partnerships, which can be as high as 40%. Ltds are also more likely to receive financial aid since they have more credibility and trust. Your business will also be liable for corporation taxes, which is calculated and paid annually based on your “corporation tax accounting period”.
Disadvantages for this kind of business structure include less privacy, since the company’s details and accounts are held on public record and can therefore be accessed by anyone. It’s not unusual to find information about the company’s directors, secretary, as well as shareholders. This kind of structure is also more complex and has time-consuming accounting and administration requirements.
Advantages and disadvantages of a limited company
Advantages of a limited company
Disadvantages of a limited company
Liability limited to owners’ share of stock
Quite expensive to form
Company is separate entity from owners
More complex and restrictive rules
Easier to get financial help
More complex and time-consuming accounting requirements
Liable for corporation taxes
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Why should you choose a limited company structure?
A limited company business structure enables you to pay less tax compared to the other entities, so running your business this way could help you take home more of your earnings. If you’re worried about being liable for what happens to your company, a limited company structure is a good choice since it limits your liability. You and your legal structure are completely separate, which gives you added protection if anything goes wrong.
This kind of structure also comes across more professional, meaning that other companies might take it more seriously and be more likely to work with you, or banks might be more likely to help you out should you need a loan.
Is it possible to change my business structure later?
How easy it is to change the structure of your company depends on if you’re VAT-registered and if you have any employees. Simply complete the usual steps to make the change to the new structure, then you have to let HMRC know. If you’re VAT registered, this must be done within 30 days or you could find yourself having to pay a penalty. Here you have the choice of either cancelling your VAT registration and re-registering, or transferring your existing VAT. This can be carried out online or by post. If you have employees working for you, you need to get in touch with HMRC since it can be a bit trickier.
More information on changing your business can be found on the Gov.UK website.