One of the first decisions you will be confronted with when running your business is whether you should form a limited company or not – but the “not” route has many more options than you might think.
If you’re already trading as a limited company, maybe there are other options you should consider. Your decision on trading structure will have implications for your tax treatment, as well as your ability to raise finance and sell your business. It will also have an impact on your personal liability.
First, let’s do a quick refresher of trading formats and look at some of the issues to consider when choosing your business structure. As usual, a quick health warning – if in any doubt, do get a professional opinion. When choosing your legal business structure, I strongly recommend talking to an accountant to get their professional input.
This is the simplest way to run your business from an administration and cost point of view. Effectively you are the business – just register as self-employed and off you go. I always advise businesses, even sole traders, to set up a separate bank account to help track income and expenses.
Because you are the business, you are personally liable for any debts of the business and you will need to complete an annual Self Assessment tax return.
A partnership is effectively a combination of sole traders running a business together. You should ensure you have a partnership agreement which documents how you are going to run the business, especially how you plan to split the profit. You should be aware each partner is liable for the actions of other partners.
The crucial distinction with a limited company is that it is a separate legal entity. This legal entity is responsible for any debts of the business, rather than the directors – contracts are signed in the company’s name.
You must register your company online at Companies House or via what is known as a formation agent. You need to inform HMRC when the company starts trading because you will need to submit a tax return in the company’s name.
You also need to tell HMRC if the company starts employing people because you must account for the PAYE and NI. There are additional costs associated with running a company too as company accounts and a company tax return are required – you can expect to pay £750-£1,000, depending on complexity.
Limited liability partnership
This is like a cross between a partnership and a limited company. It has the advantage of being a separate entity but also the potential tax benefits of a partnership.
Social enterprise structures
If you are thinking of running a social enterprise then you should be aware of the structures specifically designed for social enterprises – in particular community interest companies and industrial provident societies.
These structures tend to be liked by grant-making bodies because they do not make it as easy to distribute profit – i.e. the profit or surplus stays in the business to further the objectives of the organisation.
Guide to choosing your legal business structure
To give some context, of the roughly 4 million businesses in the UK, the legal structures split is as follows:
- Sole traders 2.3 million
- Partnerships 0.5 million
- Limited companies 1.3 million (of which over 0.5 million are one-person businesses)
Here are some issues to consider to guide your decision.
Your business name: Protecting the business name is an issue for all formats and you should consider securing yours by registering it as a trademark. Forming a limited company with your trading name can help protect the name and the company can then be left dormant to reduce running costs.
VAT: All formats will have to register for VAT when turnover exceeds the VAT threshold (currently £79,000).
Ease of starting: Setting up as a sole trader is the simplest option – it’s easy to then switch to being a limited company.
Are you planning on going into business with someone? In this case you can’t trade as a sole trader – you will need to set up a partnership, LLP or limited company BUT make sure you set out the agreement between you in writing.
Do you plan on selling some or all of the business?: You may want to look at trading as a limited company as you can then sell the shares.
Do you plan on raising equity finance?: You need a limited company to be able to issue shares.
Are you generating IP?: It may be a good idea to trade as a limited company because you can take advantage of R&D tax credits and Patent Box tax relief. This structure also makes it easier to sell or license the technology.
Do you hate admin?: Being a sole trader has less of an administrative burden than running a limited company. However, the decision has to be weighed up against other potential benefits.
Are you risk-averse?: Limited companies offer more protection because they are a separate legal entity. However, that doesn’t mean you will be protected against reckless behaviour as a director – if, for example, you blatantly ignore health and safety rules.
Growing fast – sales over £250,000?: You may want to look at setting up a limited company – it should save you some tax and limited company status can give your business more credibility with clients as you’ll be perceived as more established.
Running a social enterprise? – Look at one of the dedicated formats including industrial provident societies. Not many people know about them but it’s a good format which I have used myself as treasurer of a group of village shops! Further information on this is available from Red Ochre or Robert Ashton – specialist social enterprise advisors.
Is financial privacy important? Your financial data will be more private as a sole trader or partnership. It will be accessible via Companies House once you incorporate.
Do you sell to big companies? Some will insist that suppliers are limited companies to protect their tax position.
Can I trade with more than one format? Yes! There is nothing to stop you having a limited company, for example, AND some kind of social enterprise format.
Do you have multiple sources of income, some of which are loss-making? In this case you may want to consider LLP, partnership or sole trader status because your income (and losses) are combined. This can be useful in the early loss-making years of a business.
What is probably very clear to you is that there are a number of factors to take into account. However, my advice is don’t over-complicate things for the sake of some perceived tax benefits. Try to focus on the important commercial imperatives of funding and profits.
When choosing your legal business structure, I strongly recommend talking to an accountant to get their professional input.
For more detailed discussion of legal business structures, watch my webinar.