There are several ways in which you can structure your business. Which is best for you will depend upon what factors are important to you: flexibility, start up costs, tax issues, ongoing administration, risk and liability or raising finance?
Formalities and RegulationThis is the easiest way to set yourself up in business. You will need to inform HMRC and register with them as being self-employed. You should also consider whether your business would benefit from being registered for VAT (the turnover threshold at which point VAT registration becomes compulsory is currently £70,000). As soon as you have registered as self-employed you can start trading and, other than tax returns and National Insurance, there are very few ongoing regulations or formalities which you have to comply with.
You personally have no protection if anything goes wrong with the business. You will be personally liable for all and any debts the business incurs so if yours is a high risk business it may be worth considering a different structure which provides you with more protection.
Formalities and regulation
If you and at least one other person are carrying on a business together “with a common view to making a profit” then you are already in a partnership. You are not required to have a Partnership Agreement drawn up, but if you do not, you should be aware that your partnership arrangement will be governed solely by the Partnership Act 1890. This may not suit how you want to run the partnership, as it can be a fairly draconian piece of law.
For example, a partner cannot just retire and leave the partnership business unaffected. Under the Partnership Act 1890 the partnership will immediately dissolve if one partner decides to leave the partnership, or indeed if one partner dies. The assets of the partnership would be used to cover any debts and liabilities, and then the surplus would be distributed equally between the partners. Legally, you cannot simply continue to run the business.
A Partnership Agreement effectively “contracts you out” of the Partnership Act 1890 and will normally set out the following:
- how profits and capital are to be shared
- how partnership property is to be held and dealt with
- restrictions on, and duties of, the partners
- what will happen on the retirement or death of a partner (so that the business can continue)
- an indemnity so that retiring partners will not be liable for any debts after they leave the partnership.
As with sole traders, you will be personally liable for any debts the partnership incurs. Each partner is jointly and severally liable for all the debts of the partnership. Therefore, if a three man partnership became liable for a debt of £1 million, one partner could be pursued for the entire amount. He would however have the right to be indemnified in respect of a third of that debt from each of his fellow partners.
Limited Liability Partnership (“LLP”)
Formalities and Regulation
Formalities and Regulation
An LLP structure is similar to a normal partnership, but the key difference is that your personal liability is limited to the capital you have invested. However, in return for that limited liability there are some statutory requirements which you must comply with.
Firstly, you must register the LLP at Companies House. An LLP has ‘members’ rather than ‘partners’. You will also need to appoint one or more Designated Members who have additional responsibilities such as filing returns and notification of any changes to the LLP at Companies House. The information filed at Companies House will be available for public inspection.
A Members’ Agreement (the equivalent of a Partnership Agreement above) would govern how the LLP is run, and how events such as retirement and division of profits are handled.
It is also worth considering that while your liability to the LLP is limited, third parties, such as lenders or landlords, may well require a personal guarantee from you to back up the obligations of the LLP (especially in the current climate and if your LLP is newly formed, without substantial assets). If this is the case, then once again you will be personally liable for the full amount of that guarantee if the LLP defaults on its obliagtions.
Formalities and regulation
Limited companies are easily the most regulated of the possible business structures. They need to be incorporated at Companies House and require a memorandum and articles of association. They have ongoing requirements for filings at Companies House, and most details of the company are available for public inspection.
Companies are owned by their shareholders and managed by their directors. Practically, in smaller companies, the directors and shareholders tend to be the same people.
A shareholder will only ever be liable to a company’s creditors to the nominal value of his shareholding. For example, a person who is issued with 100 £1 shares in a company will need to pay the company at least £100 for those shares. Provided that he does this, neither the company or any liquidator can ask the shareholder to pay any further sums towards that company’s debts.
Providing that directors act within their duties and in accordance with the Companies Act 2006 then they will not be personally liable for any obligations or debts of the company and their personal assets will not be at risk.
The above factors make the Limited company structure appealing for many people.
The situation is much easier if people wish to leave the business as they can simply resign as director and sell or transfer any shares which they hold, without affecting the legal constitution of the business. The Companies Act 2006 and the company’s articles of association govern the way the company is run, but many companies also have a Shareholders’ Agreement. The Shareholders’ Agreement is private (it is not lodged at Companies House) and the terms of it are directly enforceable between the shareholders.
The Shareholders’ Agreement will normally contain provisions for the following:
- give a minority shareholder a say over certain key decisions;
- provide a method to avoid a deadlock over decisions - for example if there are two 50:50 shareholders;
- control who shares can be sold or transferred to – to give existing shareholders first refusal, or to simply prohibit transfers of shares to any new party;
- control the appointment of new directors;
- provide an exit route for shareholders – guaranteeing that they will be able to sell their shares if they wish to cease involvement with the company
- set out how and when dividends will be paid to shareholders; and
- restrictive covenants to stop a shareholder setting up in competition to the business.
You may also consider a Cross Option Agreement. The Cross Option Agreement sits alongside a life insurance policy and if a shareholder were to die the policy provides funds to purchase the shares from the beneficiaries of the deceased. The Cross Option Agreement obliges the remaining shareholder to buy, and the beneficiaries of the deceased to sell, the shares. This avoids the problem of the surviving party not having enough money to buy the shares, and also the problem of either party refusing to buy or sell the shares.
Cross Option Agreements can also apply to Partnerships and LLPs where the policy pays for the deceased partner or member’s partnership shares.
Cross Option Agreements can help ensure the continuity of the business for the surviving parties, and also a fair pay out for the relatives of the deceased.
If cash flow is an issue, or your tax payments are likely to be significant, then tax treatment could be a key consideration to your choice of business structure.
Sole Trader:You will pay income tax on your profits and national insurance contributions.
Partnership:You will pay income tax on your share of profits from the partnership. It is worth noting that you will pay tax on all profits, including profits retained in the business, compared with a Limited company where as a shareholder you would only pay tax on dividends which are actually paid to you.
LLP: Taxed in the same way as a partnership.
Limited Company:As an executive director you will pay tax on any salary that you receive from the company As a shareholder you will pay income tax on any dividends which you receive from the company. It is possible that for some transactions you may effectively be taxed twice. For example if the Limited company makes a profit it would pay Corporation Tax on those profits, and then if those profits were passed on to the shareholders by way of a dividend, the shareholders would pay income tax on the dividend they received.
You should discuss any tax issues with a qualified tax accountant to ensure you are clear on the taxation benefits or draw backs of each structure for your specific company.