Different legal structures affect the level of tax you’re expected to pay, your employment status, the formal relationship between you and your business partners, the amount of administration you’ll have to do and your personal liability for the success of the business.
The three most common business structures used by entrepreneurs in the UK are sole proprietorships (or sole traders), limited companies and partnership agreements. We’ll take you through the pros and cons of each to help with your decision.
Sole proprietorships
Sole proprietorship is the most popular option for those setting up a small business, as they’re low cost and easy to set up. There is little admin involved; you just need to choose and register a name and apply for any relevant local licences.
Under this structure, you operate your business as an individual and remain legally self-employed. This means you also have complete control. You don’t need to deal with a board of directors or any other partners.
Sole proprietorships can be a good option if you are setting up on your own, with your own money or if you want to test the viability of your business on a small scale first. They may be less suitable if you are setting up with business partners, or if you are looking to attract sizeable investment early on.
In some cases, it can be a risky choice. Your finances become your business’ finances. There is no legal difference between you and your business, and you could be personally liable for financial matters linked to the business. This can make it difficult to attract investment.
Limited companies
Setting up as a limited company means creating a new legal entity that is separate from you personally.
It’s often easier to encourage investment and raise funds as a limited company than a sole proprietor. Investors may be more willing to invest and setting up in this way also gives you the option to sell shares in your company.
As you are not personally liable for the business, your personal assets, such as your house or car, remain safe even if your company goes bankrupt. This doesn’t guarantee the success of your business any more than a sole proprietorship would, but it can offer you a level of personal protection.
Unlike with a sole proprietorship, setting up your startup as a limited company means you’ll legally be an employee of the company, usually a director. This has important implications for the tax you’ll be expected to pay. Limited companies are required to pay Corporation Tax and Capital Gains Tax. As an employee, you’ll also have to pay Income Tax on your earnings. This might mean you take home less money than if you set up as a sole proprietorship.
Setting up a limited company tends to involve far more administration than a sole proprietorship. You’ll need to register your company and file an annual report with Companies House, as well as ensuring you keep up to date with your tax and National Insurance contributions.
Limited companies represent a good option if you are confident in the viability of your business and are looking to attract significant early investment. They may be less attractive if you have less time available to work on your business, or if you are setting up individually and not looking for large sums of investment right away.
Partnership agreements
If you are launching a startup with other people, or with another business, you also have the option of entering a partnership agreement. This will typically be a limited liability partnership which operates very similarly to a limited company.
One major advantage to entering such a partnership agreement is that you and your business partners all take on shared responsibility for the business. Your roles and responsibilities can be decided on initially in the partnership agreement. This creates clarity and can help the business run smoothly in its uncertain early days.
A partnership agreement typically sets out the full terms of the partnership and often other details about the day-to-day running of the business. An agreement might include detail on the length of the partnership, working hours and holiday arrangements, who owns what, the responsibilities of each partner or how to admit new partners to the business.
Like a limited company, entering a partnership agreement involves significant administration and paperwork. It also requires agreement on a range of issues between all partners. While this might offer a good opportunity to iron out potentially important differences early on, it can also present challenges to getting up and running. Again, like a limited company, you’ll have to register your company and file an annual report with Companies House, and you’ll also have to pay Corporation Tax and Capital Gains Tax.
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