Detangling Business Structures: Which One is Right for Me?

January 11, 2019

The legal structure you choose will impact your liability, taxation, management, financing and other key issues so it is extremely important to choose the most appropriate business structure for you. In this blog post, we’ll focus on the most commonly chosen routes.

Limited Companies:

A limited company is a private company that is completely separate from its owners. This means that the owners are responsible for business debts up to the value of their investments or guarantees in the company. The main points to note are that:

  • Private companies are limited by shares (for profit) or by guarantee (non-profit). This means that the company is divided into shares and profits are distributed among shareholders depending on the value of their share.
  • A limited company can be owned, managed or registered by just one person. One person can act as a director and shareholder.
  • Limited companies have to pay corporation tax and capital gains tax on all taxable profit.
  • Shareholders receive a share of company profits in the form of dividends.
  • Limited companies can sell shares in exchange for capital investment.

Sole traders:

Sole trader is a simple form of business structure where the business is owned and operated by a single individual, and there is no legal distinction between the owner and the business. Small businesses often operate as sole traders because of the lack of legal formality and the low administration costs involved in setting up and running the business. The key points are:

  • As a sole trader, you’re your own boss and you steer the ship unaided. You can make decisions and act on those decisions quickly without having to consult directors or shareholders.
  • A sole trader can keep his or her private information and business details private.
  • Sole traders retain all profits, rather than having to share them across the business.
  • Sole traders are considered to be ‘self-employed’ and so must register with HMRC for a self-assessment as soon as they start trading.
  • Sole traders are not seen as a separate entity and are subject to unlimited liability. If the business gets into debt, the business owner is liable.
  • It can be difficult to raise funds in the business. Banks tend to be unwilling to lend large sums to sole traders due to the lack of transparency and perceived risk.

Limited Partnerships:

A limited partnership (LP) must be formed between two or more persons and will have two categories of partner:

  • General partner – this partner will have responsibility for managing the LP’s business and will have unlimited liability for the firm’s debts and obligations.
  • Limited partner – this partner will invest capital in the LP, will not take an active role in the LP’s operation, and will have limited liability up to the amount of capital they have contributed.

LPs are governed by a relatively light statutory and regulatory regime as compared to companies. An LP must be registered at Companies House but LP accounts are not generally disclosed. It also provides the benefit of fiscal transparency – the LP is not treated as an entity distinct from its members for the purposes of income tax or capital gains tax. LPs have become the most popular legal structure for private equity funds and other investment funds.

Limited Liability Partnerships:

A limited liability partnership (LLP) must be formed between two or more persons. The key features of an LLP are that:

  • It is a body corporate and a legal entity separate from its members and is incorporated by registration at Companies House.
  • With LLP members, liability is limited to the amount each member guarantees to pay should the business run into financial difficulty. This is agreed between the members in a partnership agreement which will outline rights and responsibilities.
  • In an LLP there are no shares, shareholders or directors. So, LLPs can’t receive investment in exchange for part ownership of the company.
  • It has advantageous corporate and income tax characteristics. LLPs do not have to file company tax returns or pay corporate tax and rather than being taxed itself, untaxed profits are distributed to members and then they pay the tax themselves depending on the value of their share.

The decision of how to structure a small business only needs to be made once, but you do have to make it—and what you choose matters. Tax and legal situations change based on your business structure, so it’s important to make sure you understand the implications before you fill out the paperwork.

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