Stephen Newman, Head of Corporate at Ramsdens Solicitors, discusses the legal structures that a business may use

Setting up your own business is an exciting journey, but it can be quite daunting and there are many challenges that you might stumble upon along the way. These can hinder how successfully you begin your venture.

One of the largest challenges you might face when starting your business is the way in which you decide to structure it. Having the wrong setup can cause further complications down the line and this could ultimately become a costly issue to resolve. The way you choose to structure your business will correlate to the amount of tax you will pay, the administrative work needed to run your business, how much you are personally liable for, and how well you are able to raise funds.

Stephen Newman, Head of Corporate at Ramsdens Solicitors, discusses the legal structures that a business may use, issues that might arise with each one, and how to decide on the right one for your start-up business.

Types of Business Structures

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When it comes to business legal structures, there’s no ‘one size fits all’ method. There are many different types, including co-operatives, franchises, offshore companies, and community interest companies. For now, we will focus on the most common types of business structures used here in the UK.

Sole Trader

A sole trader business structure is considered to be ‘self-employed’. This is a low-cost and easy business structure to set up.

As soon as you begin trading, you must register for a self-assessment with HMRC. You won’t be required to register at Companies House. As a sole trader, you alone are responsible for the running of your business, meaning you must meet the necessary legal requirements to do so. If you employ any staff, you’ll have to set up a PAYE payroll scheme to handle the income tax and National Insurance contributions of your employees.

You’ll also be personally responsible for any debts that the business accrues, meaning that any assets you own, such as your home, could be used to cover any debts that you cannot pay. You will be required to pay income tax and National Insurance according to the amount of profit that your business makes.

After income tax and National Insurance is paid, you are able to keep any profits accrued as you are in complete control of your business. As you earn more, your business can become less tax efficient as you reach the higher tax brackets. However, there is no limit to the amount you can earn.

Partnership

A partnership is where two or more people create or continue a business together. These are typically quite easy to form, manage and run, but profits will be split between each partner. Each partner will pay tax on their profit share and still remain liable for any debts owed by the business, regardless of which partner accrued the debt. As a partner, you are responsible for any negligence or misconduct of your other partner(s).

To set up a business partnership, you’ll have to choose a name for your business and choose a ‘nominated partner’ to register the business with HMRC. This partner is responsible for ensuring that the business’s tax returns are filed and records are kept.

Stephen recommends that you create and sign an agreement outlining the terms upon which the partnership is owned and its profits divided between each partner, as well as what will happen if a partner decides to leave.

Limited Liability Partnership (LLP)

There is no limit to the number of partners who can join, manage and run a Limited Liability Partnership. However, there must be at least two partners who are ‘designated members’ that will remain responsible for filing annual business accounts.

The LLP model protects the assets of its members (or partners) from being taken by third parties, limiting their liability to the amount of their investment into the LLP. Individual members may have personal liability; however, under any circumstances guarantees that might have been given in relation to raising loans.

Partners involved in an LLP model pay income tax on their share of the profits. Each member of the LLP must be registered with HMRC as self-employed and submit a self-assessment tax return each year. LLPs must also be registered with Companies House.

Again, it is advised that you create and sign an agreement outlining the ownership and profit split of each partner, as well as what will happen if a partner decides to leave.

Limited Company

A limited company is a business that is owned by shareholders and run by directors. The company is a separate legal entity that owns the business. It has its own legal rights and obligations, meaning the company is responsible for every action it takes. Its finances are separate from those of its owner(s) and directors.

Any profits generated by a limited company are retained by it once corporation tax has been paid. This is usually a tax-efficient option as the profits will belong to the company, as opposed to you, and the rate of corporation tax is lower than income. This profit can be distributed between shareholders in the form of dividends. There’s also the option of becoming an employee of the company to receive a wage.

To trade as a limited company, you must be registered with Companies House and have a minimum of one director. Your company must then file accounts with Companies House each year.

It’s commonly thought that a limited company is only for the use of larger businesses instead of solo entrepreneurs, but this isn’t the case. If trading as a limited company suits the needs of an individual, then by all means register one. Setting up a limited company will be more expensive than other business structures, however, and requires much more administration. One benefit of a limited company is that shareholders have no liability for the company’s debts unless they have provided personal guarantees. This means that, if your business is considered high-risk, then registering a limited company to own it might be a good idea.

How to choose the right structure for your business

Choosing which structure to operate under can be a tricky task. You’ll want to consider your business start-up’s financial needs, assess the risks, and understand how your business could grow. Your chosen structure will determine the amount of tax you pay.

Seeking legal advice before establishing your start-up business can be useful as it will help you to determine the best structure to go with and also which steps you will need to take to be successful. Without expert advice, you could risk getting into trouble later down the line.

Businesses that are successful will, no doubt, need to grow. So, expect that your business structure may need to adapt and change also. Having legal support will help make this transition as smooth as possible and will ensure that you are adhering to legislation.

Here are some important things to consider when choosing the most suitable legal structure for your business:

  • Flexibility – Think about the types of business structure that will allow for growth periods that your business might experience. Take a step back and think about your goals and objectives to further understand which structure will suit you best.
  • Complexity – It’s important that you understand what is required of you with each business structure, and whether it’s actually necessary to go down a more complicated route. For example, as a sole trader, the structure is simple to set up, but it can be tricky to raise funds.
  • Liability – Think about how much of your business’s responsibility you are able to handle. If things were to go wrong, would you be personally responsible for the costs?
  • Tax – Limited companies pay less tax on their profits when compared to the other business structures listed.
  • Control – Would you want to be completely in control of your business and its actions, or would you like to share the control with other partners who are able to help with the success and performance of the business?

Ultimately, the success of the business will depend on the business itself, its consent and planning. However, having the right structure in place before starting to trade will help you ease into the journey of having your own business, ensuring that your individual needs are met and that your business is being conducted in a legal manner.

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Stephen Newman
Ramsdens is an award-winning legal firm based in Yorkshire, with 14 offices and 150 years of heritage in the area. With 300 team members working in 12 different practice areas, Ramsdens offers the full spectrum of legal services to organisations and to the individual.