Anyone starting a new business must choose whether to set it up as a sole trader, a partnership, a limited company or a limited liability partnership.
If only one person is involved, the choice is between being a sole trader and forming a limited company. If there are two or more participants, the business could be a partnership, a limited company or a limited liability partnership.
This is the legal term used for an individual who is in business on his or her own account. They own the business and they are personally liable for all its debts. There are no registration requirements, except with HM Revenue and Customs for purposes of VAT and paying income tax on the profits made. The alternative for such a person is to set up a limited company and the pros and cons of doing this are set out below.
Two or more people
If there are two or more people, the choice is essentially between a partnership, a limited liability partnership (LLP) or a limited company. Whichever format is chosen, we strongly advise that the parties have a partnership agreement, an LLP agreement or a shareholders' agreement to to protect all their long-term interests in what may well become a very valuable business.
An ordinary partnership (often called a 'common law partnership') is just two or more persons carrying on a single business together. They jointly own the business and are personally liable for all its debts. Like the sole trader, there are no registration requirements, except for VAT and income tax. There is no legal requirement to have a partnership agreement, but it really is not at all sensible not to have one. We provide an excellent value for money partnership agreement service.
Limited liability partnership (LLP)
This is a hybrid between a partnership and a limited company. It is registered at Companies House, confers full limited liability, but has many features of a common law partnership. LLPs can now be registered electronically, and we provide a full LLP registration service, including an LLP agreement. The LLP is relatively new, and is becoming more popular. For more details, click here.
There are other business structures used in particular circumstances such as PLCs, companies limited by guarantee and community interest companies (CICs).
(For more details see our company formations page)
The pros and cons of setting up a limited company
The main factors are:
1. Limited liability
3. Name protection
4. Appearance of size
9. Floating charge
10. Outside investment
1. Limited Liability
For many people this is the deciding factor.
Starting a new business is often a risky venture. Usually people are putting their savings at risk and may be giving up their job to start their own business. It is often important limit the risk knowing that if the business fails they will not be liable beyond the capital they have put into the company. They can protect their house and other assets from being sold to pay the business debts. Without limited liability, the risk of business failure is being made bankrupt.
Note, however, that even with a limited company, it may be necessary to take on some personal risk. If the company borrows money from a bank, the bank will probably want the directors to sign personal guarantees (i.e. that they will pay back the money if the company fails to do so). Some landlords may want a similar guarantee in respect of the rent payable on leased premises.
Registered companies are subject to a different tax structure (corporation tax) from sole traders or partnerships (income tax). The choice of structure can make a substantial difference to the amount of tax paid on the same trading profits. The tax issues are complex and Incorporation Services Limited does not give tax advice. We strongly recommend that you take accountancy advice when deciding on the appropriate format for your business.
3. Name protection
The only system for the registration of business names is that for registered companies (including LLPs). If the name is distinctive and important to the business, its owners may want to have it registered as a company to prevent anybody else registering it, and to warn anyone searching the index of companies to avoid similar names.
Even if the business is to be a sole trader or partnership, a company can be registered in the same name and kept dormant indefinitely. This will prevent the same name being registered by anybody else and in practice, will tend to inhibit the registration of similar company names. For the rules on company names see our company names page.
4. Appearance of size
Bigger businesses are nearly always companies and so some small businesses are registered so as to create an impression of size. The fact that the company is on the public register also gives confidence to those dealing with the business. With internet access it is now so easy for anyone to search the Companies House index to see if the business is registered that being a sole trader or partnership (of which there are no records at Companies House) can be a real disadvantage.
There are no registration formalities when setting up as a sole trader or as a partnership (other than for VAT and taxation). Nothing is registered at Companies House, there is no official public record of the business. In the case of a partnership, though not a statutory requirement, we strongly recommend that the partners have a partnership agreement, a contract between the partners, setting out who owns the business, what their profit shares are, what happens if someone wants to leave, etc.
There are more formalities in setting up and running a limited company. These formalities are not particularly complicated. We would attend to all formalities on registration of the business at Companies House. After that, the company must register an annual return and accounts and notify Companies House of any changes to the registered details of the company or its directors. In most cases the accountant will attend to the accounts and annual return. It is only a small additional burden as accounts must in any case be supplied to Inland Revenue whether it is a company, sole trader, partnership or LLP.
The information at Companies House is on public file where anybody can see it. This includes both accounts (though for small companies this need be only a simplified balance sheet) and details of the company's directors, including share ownerships, etc. Some people prefer these details not to be on public record. On the other hand, the availability of this information can make it easier for the business to get credit, once it is established, because a search at Companies House can show that the company is stable and growing.
7. Flexibility of arrangements between the parties
A partnership between two or three people is simple to operate and the parties can adapt and change it as they go along. The company structure allows much more flexible and complex arrangements between its shareholders and directors. Practically any arrangement between the parties can be created. There can be shareholders who are not directors, and vice versa, investors can be brought in with specially negotiated rights (e.g. using non-voting shares, priority profits, other protections), family members and/or employees can be given non-voting shares to take advantage of the tax rules on paying dividends, etc. etc.
One of the advantages of a registered company is that, being a separate legal entity, it keeps going indefinitely, regardless of who owns or directs it. This can be an advantage where ownership or control is going to change, e.g. within a family, so that younger members can take over from those retiring.
9. The floating charge
A floating charge is a mortgage of (usually) all the company's assets. It is a good way of using the business assets as security for a loan. Only registered companies can create floating charges. A sole trader or partnership cannot do so. Being able to give such a security can enable a company to borrow, or borrow on better terms, that a sole trader or partnership business.
10. Outside investment
A company is ideal if outside investors are to be involved. Investors like to have limited liability, and the company structure allows different amounts and classes of shares to be used. Investment in a partnership is legally risky as someone who shares the profits of a partnership may be regarded as a partner and may incur unlimited liability for all the debts.
For further information contact us. We are here to help