You’ve got your business idea all sorted. You’ve got a great name ready to register. Now what? You need to decide which legal structure will suit you and your business best.
The four most popular ones are sole trader, limited company, general partnership and limited liability partnership (LLP). The decision is actually pretty straightforward when you understand the basic features and benefits of each structure, so we’ll take a look at each one in turn to help you make the right choice for your exciting new venture.
A sole trader is a self-employed person who owns and manages a business as an individual, but they have the option to employ people to work for them. To operate as a sole trader, you must register with HMRC as a new business. You will be required to keep records, file an annual Self-Assessment tax return, and pay Income Tax and National Insurance directly to HMRC at the end of each tax year. You must have a National Insurance number to register as a sole trader, so this structure is unsuitable for non-UK residents.
- Ideal if you want to set up a business on your own.
- Quick, simple and free registration process.
- Suitable structure for undischarged bankrupts and disqualified directors.
- Pay 20-45% Income Tax on annual profits above your £11,000 tax-free Personal Allowance.
- Pay Class 2 National Insurance (£2.80 per week) when profits reach £5,965.
- Pay Class 4 National Insurance at 9% on profits between £8,060 and £43,000. An additional 2% is charged on profits above £43,000.
- Required to keep a record of business income and expenditure.
- Suitable for all types of business activities.
- Registration for the 2016-17 tax year must be completed by 5th October.
- Perfect for very small businesses with profits below £20,000 per year.
By operating as a sole trader, there would be no legal or financial distinction between you and your business. Business debts would be your responsibility alone, so it’s not the most suitable structure if you’re planning to carry out high-risk business activities or bid for high-value contracts.
A limited company is a business structure that is separate from its owners. It’s not like a sole trader business in which the owner and business are one and the same – a company exists as an distinct ‘individual’. By setting up a company, you can protect your personal assets from being seized by creditors if the business racks up debts that it cannot pay. There’s more upkeep and red tape to negotiate, but you’ll enjoy a more professional and prestigious status by operating through a company.
Limited by shares or Limited by guarantee
Companies can be set up as limited by shares or limited by guarantee. The limited by shares structure is preferred by profit-making businesses because the company can be divided into parts (shares) and owned by multiple people (shareholders). If you want to run your company as a non-profit or charitable venture instead, the limited by guarantee structure would be best. Profits would not be distributed to the owners – the surplus income would just be retained by the business and used to achieve its non-profit objectives.
- Can be set up by one person, two people, or multiple people.
- An incorporation application must be submitted to Companies House.
- A small fee is required to set up a company.
- Minimum requirement of one shareholder or guarantor.
- Minimum requirement of one director (can also be the shareholder or guarantor).
- Limited by shares companies can issue any number of shares, with a minimum requirement of one per shareholder.
- Company details are disclosed on public record, including information about finances, directors and shareholders.
- 20% Corporation Tax liability on annual profits.
- Personal remuneration must be taken as a salary or dividends – you cannot just remove money from the company whenever you like.
- Companies must follow strict rules and regulations, including the filing of accounts, reports and tax returns.
- Suitable for non-UK residents.
- Suitable for all types of business activities.
- Company name is protected upon incorporation.
- A registered office address must be maintained in the country of incorporation.
- Can be more tax-efficient for businesses that generate annual profits above £20,000
Company registration can be completed online through an agent or Companies House. Applications are usually approved in less than 3 hours.
Ordinary partnerships and LLPs
An ordinary partnership is a traditional business partnership structure in which two or more people set up a profit-making venture, share responsibility and profits, pay individual tax and National Insurance on their share of these profits and file their own Self-Assessment tax returns. They also assume responsibility for the business’ actions and debts – if the business is sued or can’t pay its bills, the partners are wholly and personally liable. There is no legal or financial distinction between the business and the partners. Ordinary partnerships need only register with and report to HMRC.
The LLP structure was introduced in 2001 as an alternative business form for accountants, solicitors and other similar professional services firms. Limited liability partnerships are exactly the same as ordinary partnerships – they benefit from the same tax transparency and internal flexibility – but the partners enjoy limited liability for debts because the business exists as a legal ‘person’ that is separate from the partners. If the LLP can’t pay its bills, each partner’s liability is restricted to the money they have invested in the partnership. It’s basically a hybrid of a general partnership and a limited company. As such, LLPs must be incorporated through Companies House and report to both Companies House and HMRC.
Partnerships are only suitable for businesses that are set up with the intention of making a profit. You cannot use a general partnership or LLP structure for a non-profit or charitable venture.