When you’re preparing to start up your own business, there will be plenty of tasks to keep you busy
One of the most important decisions you will have to make is the legal structure you are going to operate your business under; OK, it’s not as exciting as thinking about your branding, negotiating with suppliers or fine tuning your marketing plan, but the way you structure your start-up has long-term repercussions that will affect you personally, as well as your new business.
In simple terms, there are three structures to choose from – sole trader, limited liability company, or partnership. Each offers advantages and disadvantages which have differing implications on:
The tax you will be liable to pay
- The level to which your personal assets will be protected in the event of the business failing
The time and cost you will have to dedicate to administrating the business
This is the easiest type of business to set up, requiring you to simply register as self-employed with HMRC. There’s no legal requirement to have a separate bank account for your business, and you can use your personal account if you want to. Sole traders are required by law to keep records showing business income and expenses.
You will be required to pay tax on any profit you make, and if the business makes a loss, you may be able to offset it against other income in the current, or preceding tax years, which makes it an attractive option for businesses with large set-up costs and little or no initial revenue.
The most important thing to be aware of as a sole trader is that your personal assets are not protected in law. This means that if you fail to pay debts, or your business ceases to trade owing money, your creditors may have a claim on your personal assets like your home or car.
Limited liability company
Limited companies are often associated with large corporations, but in fact they can consist of just one person. Their major advantage over other business types is that the directors of a limited company are fully protected against liability should the business fail (except in the event of fraud or negligence), so creditors will have no call on personal assets.
A limited company is classed as a separate legal entity, and is more costly and onerous to run and administrate than a sole trader. It must be registered at Companies House, and is required to submit an annual report detailing its full financial position.
A limited company can offer tax advantages to its owners. The company itself pays Corporation Tax on profits, after which it can pay dividends to its directors who will be personally liable for any tax based on their own individual circumstances.
An ordinary partnership is effectively 2 or more sole traders working together and sharing profits or losses based on their share of the partnership. The partnership must be registered with HMRC, and each partner needs to register as self-employed.
A further variation is a limited liability partnership (LLP), which offers the same tax treatment as a sole trader, but gives protection to the owners in much the same way as a limited company does. A partner’s liability is limited to the amount of money they have invested in the business.
An LLP requires a separate bank account as well as the same formal set-up and reporting requirements as a limited company, so there are cost implications to take into account.
As a business grows and develops over time, it’s possible to alter its structure in order to maximise tax efficiency, and enhance protection levels, but getting it right at the outset will avoid unnecessary costs.