There are a number of different options for the structure of your business. Here we summarise the key features of each of the different structure types, plus the advantages and disadvantages of each.
What is a limited company?
A limited company is a standalone legal entity, with its own finances and company name.
The owners of the business are its shareholders who are entitled to distributable profits from the company after the payment of corporation tax.
- Limited liability – Company finances are kept separate to the finances of the shareholders and directors, who cannot be held personally responsible, or their personal assets pursued, if the company is unable to pay its debts. It is also possible for a limited company to secure a loan without the need for its directors/shareholders to provide security for it against their personal assets
- Protected identity – Individual limited company names are registered with Companies House. All company names must be unique, meaning another business will not be able to use the name of your company
- Professional status – Limited company status can give credibility to your business and lead to your business being held in higher regard due to the more rigorous reporting and accounting obligations involved. Some business and agencies will only deal with limited companies for this reason
- Tax efficiency – UK limited companies currently pay 19% Corporation Tax on profits, whereas sole traders pay 20-45% income tax on their profits. Surplus limited company profits can be retained in the business, rather than withdrawn by its shareholders. The withdrawal of profits by shareholders can also be delayed to a later year, if they stand to take a shareholder(s) into a higher tax bracket
- Remuneration efficiency – Limited company shareholders can be paid via a combination of salary and dividends. Dividends are taxed at lower rates than other income and they can keep salary payments at a level lower than the primary threshold for national insurance contributions (NICs), thereby avoiding the need to pay income tax and NICs on these earnings
- Registration obligations – Limited companies must be incorporated at Companies House for which a fee is charged
- Accounting obligations – Limited companies are required to keep accurate, up to date accounting records and submit these to Companies House annually
- Public reporting obligations – Company registers and statements must be updated and submitted to Companies House each year so they are available to the public, including a Confirmation Statement, company tax return and annual accounts
- Procedural obligations – There are robust procedures which must be followed when money is withdrawn from a limited company, plus protocols for record keeping, including meeting minutes and declarations
What is a sole trader business?
A sole trader is self-employed. They run their business as an individual and can also have employees.
- Minimal registration requirements – there are no registration requirements to set up a sole trade business beyond registering for Self-Assessment with HMRC
- Extraction of profits – After a sole trader has paid income tax, surplus business profits are available to the business owner for personal use
- Minimal accounting and reporting obligations – Sole traders have less formal records to keep and accounting costs tend to be cheaper than for limited companies
- Private business data – There is no requirement for a sole trader to make detail of the business ownership, business records or financial accounts available to the public
- Unlimited liability – There is no legal distinction between the business and the owner, meaning the owner remains liable for any and all business debts and liabilities, and their personal assets can be pursued in the event the business is unable to meet its financial obligations or is subject to legal action
- Rate of Income Tax – Sole traders pay income tax at rates of between 20% and 45%
- Lack of professional status – Sole trade businesses tend to be less highly regarded than limited companies and there are some organisations that won’t do business with sole traders
- Tax drawbacks – Sole traders have no option to defer profit withdrawals until a later tax year or reinvest surplus profits in the business without paying tax
- Sole responsibility – Sole trade businesses can only be set up and owned by one person, meaning the pressure to make the business a success lies entirely on the individual’s shoulders
What is a partnership?
A partnership is formed when two or more people come together to form a business and share responsibility for it. The partners share the business profits and are individually responsible for paying their share of tax.
- Registration obligations – A partnership can be set up verbally or in writing with no registration at Companies House required, beyond each partner registering for Self-Assessment
- Shared responsibility and knowledge – The partners of the business share responsibility for business tasks, and can therefore share the business burden and work to their strengths. They can also benefit from the skills, knowledge and profile of the other partners
- Shared decision-making – The partners can use their combined knowledge to solve business problems and make decisions
- Limited accounting and reporting obligations – There are no obligations to file company statements with Companies House and the accounting process is simpler than that for limited companies
- Business privacy – The affairs of the business are not on public record
- Access to profits – The profits of the business are shared between the partners
- Potential for conflict – Different partners can disagree on how the business is run and struggle to make decisions
- Tax drawbacks – Similar to sole traders, partners must pay their own tax on the business profits. Unlike with a limited company, the partners do not have the option to withdraw profits as dividends when business profits reach higher rates of taxation
- Joint and several liability – The partners are personally liable for the debts of the business. Plus, if one partner is unable to settle their debts, the other partner(s) are responsible for doing so
- No independent legal status – In the absence of a Partnership Agreement stating otherwise, a partnership is automatically dissolved when a partner resigns or dies
- Exit strategies – Complications exist when a partner wishes to exit the partnership
What is a limited liability partnership (LLP)?
Like a partnership, an LLP is run by two or more people but they are not personally liable for the debts of the business. Instead, their liability is limited to the amount of money they invest in the business. An LLP Agreement is put in place to control the individual partner’s profit shares and to determine respective responsibilities.
- Shared liability and responsibility – The partners of the business share responsibility for business tasks, and can therefore share the business burden and work to their strengths. They can also benefit from the skills, knowledge and profile of the other partners. Financial responsibilities and liabilities are shared between the partners
- Flexible partner contributions – This structure allows for flexible partner contributions and an unlimited amount of business partners
- LLP Agreement restrictions – Conflict can arise if a partner is restricted via the agreement about what they can and cannot do