In this podcast, Josh Hall talkes about 'Choosing a Legal Structure’. Listen to the podcast or read the podcast on this page.
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There is a range of legal structures available to business owners. Every business has a legal structure, whether or not it’s registered with Companies House. This is where the distinction between a business and a company lies; a firm is only legally referred to as a company if it is incorporated at Companies House.
Your choice of legal structure can have a number of important, practical implications for you and your business. This choice can affect the amount of paperwork you have to complete, the legal protection you are afforded, and the ways in which you raise finance.
So what are the main legal structures on offer?
Most entrepreneurs choose to operate initially as a sole trader. This is the simplest legal structure available, and many business owners like the flexibility it offers.
As a sole trader you make all the key decisions relating to your business. You alone are responsible for its success, and you can keep all the profits if you so choose.
Sole traders do not have to register at Companies House, and do not have to deal with corporation tax. Instead, sole traders complete an annual Self Assessment tax return, and declare all their business income and expenses through that process.
But this legal structure has a significant drawback. As a sole trader, you are entirely liable for any risks associated with the business. The business is not treated as a separate legal entity – so if you take out a loan or you get sued, you are personally liable.
This lack of legal protection is one of the main reasons that many business owners instead choose to set up a limited company. This legal structure offers you an increased level of protection from liability. A limited company – that is, one that is incorporated at Companies House – is treated as a legal entity in its own right, separate from its owner. Loans are taken out in the name of the company, rather than in your own name, and the company is liable if it misses payments.
As the owner of a limited company, your financial liability is normally limited to your initial investment. So, if you put £10,000 of your own money into the company and it then goes bust, theoretically speaking the most you stand to lose is £10,000.
Limited companies also have more options when it comes to raising finance. You can sell shares in your company and, eventually, you might choose to float on a stock exchange. It is also often easier for limited companies to secure conventional loans – although you should be prepared for lenders to look at the creditworthiness of directors, at least in the early stages of your business.
Profits made by limited companies are subject to corporation tax. As a director you are considered to be an employee for tax purposes.
Of course, not everyone wants to go it alone. Many people choose to set up a business with one or more others. In these cases, a partnership might be the way to go.
Partnerships can be a very flexible way of doing business. Partners in the business assume shared liability, and each take a share in the profits.
It is always best to draw up a written agreement when forming a partnership. This agreement should outline the role of each of the partners, and explain how the profits will be split. This can help to prevent conflict later on.
If you want to operate as a partnership but you also want to avoid personal liability, a limited liability partnership might be the answer. Limited liability partnerships are incorporated at Companies House, just like limited companies.
In a limited liability partnership, the liability of the partners is limited to the amount of money they put into the business. Two or more partners are appointed as ‘designated members’, and these individuals have legal responsibility for things like filing documents.
Regardless of the legal structure you choose, at some point you will have to register with the taxman. HMRC will contact you soon after you incorporate a company or partnership at Companies House, and you will need to fill in a form to provide them with the information they need.
But you will need to register with HMRC even if you choose to operate as a sole trader or as part of an unincorporated partnership. In these cases you will have to register to pay tax through the Self Assessment process – as do company directors.
This aspect of running a business can be confusing. So, in the next edition of the Simply Business podcast, we will be helping you understand business tax.