Sole Trader, Partnership or Limited Company?
Too often when an entrepreneur is starting a business the excitement and enthusiasm is focused on just getting it going and building the business. They will jump into action without necessarily thinking too much about the legal structure of the business or the type of business we are creating. This is especially common for people who are just keen to strike out on their own.
There are however several ways to create a business. The most common in the UK are:
- Sole Trader
- Limited Company
When deciding to create your own business in the UK you would probably consider setting it up as a sole trader or a sole proprietor. It is one of the most popular business types for ‘one man band’ operations because it is very easy to set up. You as the sole trader retain full control and ownership. You own all the assets of the business and any profits made. On the flip side, you are also responsible for all the debts and liabilities the business accrues.
Although easy to establish there are significant drawbacks to setting your business up as a sole trader. The biggest drawback is around liability. As a sole trader, the business is not a separate legal entity to you as an individual. This means that if the business gets into debt or the business is sued you are personally liable. Worst case is you could lose your own personal assets such as a home or your savings etc.
A partnership is the business structure often chosen when two or more people go into business together with the intention of making a profit. It’s always wise to create a formal agreement between the partners to set out the terms of the partnership.
Partners share the decision making, any profits the business makes and also any debt the business accrues. If the business runs into trouble both partner’s personal assets may also be at risk. Also, as there is no legal entity, once the partners retire, die or move on, the business ceases to exist.
There is another type of partnership that exists known as a limited liability partnership (LLP). This ensures that the individual partners are not personally responsible for the debt the business accrues. The partners still share the running of the business in the same way as partners in an ordinary partnership, but avoid the personal risk to their own finances in the same way as shareholders in a limited company avoid personal liability. The other main difference is that limited liability partnerships must be registered with Companies House.
When it comes to limited companies it’s easy to assume that they are only appropriate for the big companies or for businesses where there are multiple partners. However, changes in UK law means that a single founder can create a limited company and own 100 percent of the shares. Alternatively, one or more partners can form a limited company by registering the business with Companies House (UK registrar of companies) as ‘limited by shares’ or ‘limited by guarantee’. When a company is ‘limited by shares’ they are owned by one or more shareholders and managed by one or more directors. Limited by guarantee companies are owned by one or more guarantors and managed by one or more directors. The same person can be the owner and director, so you can set up a company by yourself or with other people. Each partner (or shareholder/member) is then allocated shares in the company. If they are equal partners then the shares are equal, if there is a less active partner then the share allocation may be altered to reflect that.
There are many advantages of forming a limited company over the other forms of business. For a start, the business becomes its own legal entity which means that it will survive beyond the life of the business partners. This is very important if you have an exit strategy that involves selling the business.
With a sole trader or ordinary partnership, as profits increase you will be subject to higher personal tax rates. However, if you set up a limited company from the outset the business will pay corporation tax (20% in 2017), making it much more tax efficient.
Obviously, it’s always wise to speak to a professional about your plans so they can help you make the right decision but if you plan to create a business that you may one day sell then a limited company is almost always the best option.
Contact me for more information on how I can help you to make the most of your business.