Starting your own business is exciting but does come with some important decisions of which the first is what legal structure is going to be best for you. The structure you choose determines how you pay taxes, what your personal liability is, how you manage your accounts, and how you grow your business.
In the United Kingdom, the three most prevalent business forms are limited companies, partnerships, and sole traders. Each one clearly has its own set of pros and cons, as well as its own legal obligations. By the end of this guide, you will have a better understanding of these structures so you can choose the one that makes sense for your business needs and circumstances.
Sole Trader: A Simple Start
What Is a Sole Trader?
The simplest and most straightforward business structure is a sole trader. You own the business and are personally responsible for it, and your business’s profits and debts.
Pros of Being a Sole Trader
- Ease of Setup: It’s quick and easy to set up as a sole trader. The only requirement for self-assessment is to register with HM Revenue and Customs (HMRC).
- Full Control: You are the sole decision maker, and you are in charge of the business operations.
- Lower Administrative Burden: Unlike limited companies, sole traders are subject to little paperwork and little regulation.
Disadvantages Of Being A Sole Trader
- Unlimited Liability: Any business debts are your personal responsibility, so you are personally liable, and your personal assets, such as your home, are at risk.
- Limited Growth Potential: The difficulty is in raising capital, which you try to do by using your personal savings, bank loans, or small business grants.
- Tax Efficiency: Income tax is charged on a profit for sole traders and profits can become less efficient for higher earnings compared to the potential tax benefits for a limited company.
Who Is It For?
Individuals, being self-employed, who offer professional services such as consultants, freelancers, or tradespeople can be sole traders, as can smaller businesses, which don’t need to expend great sums. Contact accountants for freelancers to achieve a better understanding of this matter.
Partnership: Shared Responsibility
What Is a Partnership?
A partnership is formed when two or more people have a share in a business, their profits and responsibilities, and their liabilities. Partnerships exist in two umbrella types – general partnerships (unlimited liability to partners) and Limited Liability Partnerships (LLP) which came into existence to provide limited liability to partners.
Advantages of a Partnership
- Shared Resources and Expertise: It means you can bring together skills, expertise, and financial resources through partnerships.
- Relatively Easy Setup: It is easy to register as a general partnership with HMRC. An LLP must register with Companies House and it is less administratively burdensome than a limited company.
- Potential for Growth: A sole trader might have to grow very, very slowly but can employ a partner(s) who can combine their resources with yours to grow the business as quickly as possible.
Disadvantages of a Partnership
- Unlimited Liability: It is a general partnership, which means that all partners in the business are responsible for the debts of the business, regardless of who actually incurred those debts.
- Risk of Disputes: Conflicts among partners can arise out of different visions or management styles.
- Shared Profits: Partners have earnings split between each other, and could dilute each person’s earnings.
Who Is It For?
Professionals such as accountants, lawyers, or architects are well suited to partnerships; small businesses run by families or close associates are also well suited. Those who want the benefits of limited liability but the flexibility of a partnership will usually prefer an LLP. It is always good to consult accounting services for small business, before making a decision.
Limited Company: A Professional Choice
What Is a Limited Company?
A limited company is a separate legal person from its owners (shareholders) and directors. It provides limited liability protection for business debts — with personal assets not at risk. There are two types of limited companies – Private, (Ltd); and Public, (PLC).
Advantages of a Limited Company
- Limited Liability: It limits shareholders’ liability to their shares – that is, their personal assets are protected.
- Tax Efficiency: The taxation that limited companies pay is corporation tax (currently 25% at profits over £250,000 from 2024). Dividends can be paid out on profits, too, and taxed at a lower rate than income tax.
- Credibility and Growth: Operating as a limited company gives you a stronger profile with clients and investors and makes it easier to attract funding and contracts.
Disadvantages of a Limited Company
- Administrative Requirements: Companies House requests to file annual accounts, corporation tax returns, and confirmation statements.
- Costs: A limited company is more expensive to set up and run than a sole trader or partnership.
- Legal Responsibilities: According to the Companies Act 2006, directors are responsible for the company being run.
Who Is It For?
If you are looking for limited liability protection, a limited company is the best route for businesses with growth ambitions, those looking for external investment or those simply looking for the best choice of company structure. Additionally, it’s useful for contractors in IT, and in other industries where clients might like to work with incorporated businesses. Get in touch with an accountant for contractors for better clarity.
Conclusion
Picking the proper business structure for your fledgling business is a massive step. It doesn’t matter whether you begin small as a sole trader, join forces with a partner, or go big with a limited company—you need to know the legal and financial implications.
There’s a lot to consider: Your business goals, liability tolerance, tax implications, and growth plans. If you’re unsure, speak to an accountant who knows what they’re doing and you can get your business off on the right foot.
Here at Finbridge we focus on assisting UK entrepreneurs to understand business structures and taxation. To get tailored advice for your business journey, contact us today.