Starting a Business?

Most new businesses are structured in one of three main ways: either as a sole trader, a partnership, or as a limited company. The purpose of this guide is simple: to explain how each structure works — and to help you decide which will be the best fit for what you, and your business.

Why is the choice of business structure important?

Running a business brings with it many rewards andvresponsibilities. As we’ll see, two of the biggest ways in which business structures differ concerns how and when you can remove money from the business — as well as the way in which you are taxed. So the structure you choose determines how thesebimportant ‘ins and outs’ of your business are dealt with.

But far from being all about admin, the right structure can go a heck of a long way in actually strengthening your business. It can allow new people to get involved, while setting out in black and white the terms of the business relationship at the same time; to avoid misunderstandings down the line. As an example, it can enable investors to back your business in exchange for a clearly defined stake. It can even help you win more customers by giving your business the type of image they trust and support.

In a way, selecting a structure is rather like choosing a company vehicle. You want to run it efficiently with the minimum of hassle. It should be able to take on board essential passengers, and, ideally, it should showcase the right message on what your business is all about.

So, here are the essentials of each of these three main types of company structures.

Sole trader

Should you operate as a sole trader?

Think of the sole trader model as the ‘default’ structure. If you have already started your business, but you’ve not yet set up any other structure for it, then by definition, you are a sole trader.

You can set up as a sole trader by registering with HMRC — a quick and easy process for informing the tax man that you are ‘in business’. You’re then provided with prompts at the appropriate times for submitting your annual Self Assessment tax return and for paying Income Tax on your profits.

With this model, there is no separate structure for your business. For legal and tax purposes, you and it are basically the same thing.

Let’s say you are still employed, and you want to gradually move towards going it alone; perhaps with some consultancy work or art-time projects. You don’t need to raise any finance for this, nor do you need to get any outsiders involved in the running of the business. Your requirements are simple, and becoming a sole trader could be the most straightforward way of meeting them.

Even as your business expands, this model might still fit the bill. For instance, it’s possible for a sole trader to register as an employer and take on staff. So you could, in theory, be a sole trader and have a workshop full of employees.

The fact that there is no legal distinction between you and your business can also have practical advantages. On the money side, while it is important to properly keep track of your finances for tax and accounting purposes, there is no legal requirement to keep a separate bank account for a sole trader business. Essentially, you can take money out and put money into your business as you please — although it’s important to always earmark enough money to cover your upcoming commitments.

But there can be drawbacks to this, too. In a legal sense, there’s no line between ‘business’ and ‘personal’; so if the venture hits a difficult patch, you are personally liable for all debts that arise. It also limits your options if you are looking for financial input. When an outside investor agrees to back you, it’s usually in exchange for a stake in the business. However, as the business does not exist as a separate entity, it becomes impossible to subdivide it into shares in exchange for cash.

In terms of your business structure then, keeping it simple can suit you well in the early days. But as your plans develop, and you think about taking on further commitments, an alternative vehicle might better suit your needs. If you want to find out more information on being a sole trader, just pop over to our Help Centre.

Partnership

In law, a ‘business partnership’ describes the relationship between two or more persons as “carrying on business with a view of profit”. So let’s say two or more of you decide to go into business, and you agree to share the profits (instead of one of you employing the other). Unless you intend to set up a company, you are, by definition, about to set up a partnership.

Although it’s not a legal requirement, it’s highly advisable to have a partnership agreement in place. If you don’t have this, or if a particular point is not covered in the agreement and if there is a disagreement later on, any dispute will be resolved in line with the standard provisions set out in the Partnership Act 1890. If this happens, the outcome might not reflect the reality of your business relationship and what you thought you’d agreed to.

Through a well-drafted partnership agreement, it’s the partners themselves who determine what the structure of the business actually looks like. You and your partner(s) are in control and can choose almost any conditions — as long as you all agree. To ensure you get it right, it’s good practice for each partner to get independent legal advice before entering into the agreement.

You might want to think about what proportion are profits (and losses) to be shared, for example. How are decisions going to be made and day-to-day responsibilities allocated? What happens if a partner wishes to leave? These are some of the key points that a partnership agreement will cover, and the end result should be a structure that reflects the precise nature of your relationship.

Should you go into a partnership?

In many areas of business, a partnership can be ideal for driving a venture forward where multiple people are on board. Often, this is where you each bring unique and complementary skills, knowledge, resources, and contacts to the business.

Let’s say for instance, that you have some capital to invest and a good working knowledge of the property market, so you’re keen on setting up a renovations venture — but you’re lacking in project management and construction skills. The ideal partner would fill these gaps in your business. A partnership agreement gives you the flexibility to define how that relationship will work in real life: each partner’s rewards and responsibilities are clearly understood and set out.

A partnership also allows you to bring on board ‘sleeping partners’. An example of this might be a friend or family member who agrees to contribute capital to the business. This person does not want anything to do with the running of the business, but could expect to receive an agreed salary or company shares in exchange for their investment.

With a partnership, you are defining the relationship between the individuals involved in the business. What you are not doing though, is creating a separate legal entity.

So why is this important?

Well firstly, tax. It’s not the business that’s taxed (as far as HMRC is concerned, a partnership is not a distinct body capable of being taxed). Instead, each partner is taxed on their share of the partnership’s profits. Legal liability is another important point. If the business runs up debts, then so far as a creditor is concerned, each partner bears equal responsibility for meeting those debts. As in the case of a sole trader, there is no distinction between the business and the individual partners when it comes to liabilities — the debts of the business are your debts.

With a partnership, the ability to pool your resources can make it easier to apply for business finance. If you jointly apply for a loan and each of you has assets to put down as security, a bank may see this as a ‘safer bet’ than a loan to a sole trader. For securing outside investment however, most professional backers (such as angel investors) prefer to deal with a limited company rather than a partnership setup. Once you compare a partnership with a limited company, the reasons for this become clear.

For more information on business partnerships, just head over to our Help Centre.

Limited company

By forming a limited company, you’re creating a distinct legal body to trade under. In other words, you are creating a whole new structure. This might sound like a big step to take for a small business, but it’s actually something that can be done easily, quickly, and inexpensively —The Formations Company offer a range of small business-friendly ways to go about this.

Maintaining that structure — i.e. keeping a company going — is a slightly more involved process in comparison to being a sole trader business or forming a business partnership. You have certain annual reporting obligations to keep on top of, for example. With these, you are essentially keeping Companies House and HMRC up to date with what is happening with your business. But again, as our guide to company reporting explains, the ability to file your essential documents online means that this need not necessarily be a burden.

By law, a company categorised as a separate ‘person’. Accordingly, it has its own type of tax which you may have heard about: Corporation Tax. It has its own credit record, too, and it can apply for loans, own property as well as other assets, and even make investments in its own right. What’s more, if it defaults on its financial commitments, it’s the company itself that’s held responsible, and not you. As such, a company is referred to as a “limited liability” structure. Through a limited company, it becomes possible to make a clear distinction between your own finances and those of your business. However, especially in regards to large loans, any lender is likely to require a personal guarantee from the company owner if the assets of the business are insufficient to properly secure the loan.

Compared to sole trader businesses and partnerships, a limited company provides a great deal of flexibility to involve other parties in the ownership of the business. This might include investors, employees, or perhaps family members as shareholders. Through the creation of company shares, you have very precise units representing the value of your business. As a company director (i.e. the person responsible for day-to-day running of the business), you might be the sole shareholder. But equally, you can use shares as a way of transferring financial interest — without losing control of your business.

Should you structure your business as a company?

Firstly, no two companies can share the same name. As it is so easy to form a company, one option for any small business is to set one up under your name of choice as a fallback. You might continue to operate as a sole trader for the time being, but you maintain the company as dormant to protect your business name.

In terms of running your business, you might be able to manage perfectly well as a sole trader. There may, however, be a very good marketing and branding reason for structuring as a limited company. Having that ‘Ltd’ title after your business name can give it an air of professionalism, for instance. It looks official, trustworthy, and can stop you giving the impression of being a ‘one man band’.

A company structure does bring certain restrictions with it, though. You cannot, for example, simply put money in or take it out of the company account as and when you please. There are set procedures for this: notably, paying yourself a salary as a company director or through withdrawing company profits through share dividends.

This element of a company structure might seem unnecessarily complicated, but actually, it can have its benefits. Withdrawing money from a company through dividends can be very tax efficient. Depending on your wider financial situation, structuring as a company may mean paying less in tax, overall.

For information on limited company formations, check out the Help Centre.

Choosing your structure

It shouldn’t be a case of having to radically alter your plans or your preferred way of doing things just to suit a particular company structure. After all, it’s your business, and the structure should help you in achieving your goals, not hinder them.

Nor is your choice of structure a once-and-for-all decision. Businesses evolve and plans change all the time. So if a sole trader structure suits you just fine for now, there’s always the option of setting up a company later on. From tax through to organising your small business in the best way to suit your needs, all you need to do is have a browse our help centre for a range of resources to help you get off the ground.