There are 4 main types of business structures in the UK. Each has various tax and liability implications for owners and shareholders. This decision to choose a structure will influence everything from your daily operations, taxes, the amount of required paperwork, your personal assets to your funding ability.
1. Sole trader
3. Limited liability partnership
4. Limited company
Determine the best structure you can benefit from by reviewing the pros and cons of each. Here’s what you need to know if you want to set up a company in the United Kingdom, along with its pros and cons.
This is also known as the simplest form of business you can register, with a low barrier to entry since you can start one without a huge cash pile.
As operating as a sole trader requires minimal setup and paperwork, this business structure is common for new businesses. You will be considered a self-employed sole trader working for yourself and while you do not need to register at Companies House, you must notify Her Majesty's Revenue and Customs (HMRC).
The business will be solely run by you, with fewer regulations and filing requirements. Being a sole trader means your decisions can be implemented instantly without having to convince a colleague or a board member, or having competitors steal the first-mover advantage.
You will be entitled to keep all your profits as income, but liable to national insurance and tax through a Self Assessment Tax Return form. There is also no maximum amount you can yield, although it can become less tax efficient in the higher income tiers.
Additionally, you can also make the decision to hire employees if you wish, as long as you abide by the rules of recruiting an individual as a sole trader.
While the position of a sole trader can be independent and efficient, the journey can also be an exposed and lonely one with no one to validate your path. Since the business is not a legal entity on its own, this means that the company's owner is liable for all its debts and legal actions. This takes into account all your personal assets, including those jointly-owned with another individual. In the case of the owner's death, the company usually will not see subsequent succession.
Sally starts her own business in the United Kingdom and registers as a sole trader. Everything was going well until the global pandemic affected her business. Under such circumstances, she was forced to shut her business and has incurred debts. As a result, she had to declare bankruptcy, losing her house and car in the process.
In a partnership, two or more individuals are involved in the business. If you are offering services with trustworthy individuals, a partnership might be the right option for you. Think of partnerships as an extended model of the sole trader business structure, for example when two siblings join hands to build the company.
When setting up a business partnership, you will have to choose a company name, a 'nominated partner' and register with HMRC. Your partner can either be a legal person or a limited company. The 'nominated partner' will be in charge of record-keeping and managing the partnership's tax returns.
This structure is almost as flexible as the sole trader route, but with the advantage of two or more brains, which means that the company's operations can go pretty much unaffected if one partner is sick or requires a time-out. There is also more potential to raise funding if required.
A partnership agreement is bound by ownership, liabilities, the splitting of profit margins and what happens when a partner decides to leave. Each partner has to be registered as self-employed, and your share of the profit will be taken into account as your income tax.
As with sole traders, all partners are liable for any debts incurred by the company. Keep a close eye on the conduct of those you venture into business with, as you are not only responsible for the debts you owe as a partner, but also those of any of your partners. Partnership disagreements may also arise in the process.
Michael and Skyler decided to set up their own company and form a partnership. They saw some neat returns after the first year of operation, paying their individual taxes. One day, Michael made a huge loss in the casino and took some of the company’s money without Skyler’s knowledge. Due to the lack of cash flow, the company was forced to close and Skyler had to single-handedly repay the debt.
Limited Liability Partnership (LLP)
This legal structure does not limit the number of partners but requires at least 2 'designated members' accountable for filing annual accounts. An LLP operates in a similar way as a traditional partnership, but with the benefit of limited liability. This business structure is typically profit-driven and favoured in trades such as accountancy and law.
In an LLP agreement, members' responsibilities and profit share are outlined and every member will have to file a personal Self Assessment Tax Return annually, pay National Insurance to HMRC and income tax on their profits.
The partner does not have to bear full responsibility for the business and is only liable for the amount of money invested, including any personal guarantees given when raising funds.
Additionally, flexibility can also be incorporated within the members' agreement.
Each member has to be registered with HMRC as self-employed. The LLP should also register with Companies House, with annual accounts prepared and filed.
Elizabeth sets up a company together with her best friends, Mary and Joanna. When the going gets tough, she has additional brains to tap on. In her haste to expand the business, Joanna makes an unwise business decision and had to be held liable for her actions. However, Elizabeth and Mary remain unscathed and their personal assets are still protected.
Limited Company (Ltd)
This business model is privately managed, owned by shareholders and run by directors. The process requires the registration of a limited company or Ltd. at Companies House, lending credibility to the business. During hard times, this position will make raising funds a lot easier. This also means that the company has shareholders, with their liability to the company's creditors limited to the sum they have originally put in. Limited companies have to pay an application fee, with the following requirements:
- The company's name and registered address
- At least one director over the age of 16
- At least one shareholder
- Information on the company's shares
- Guidelines on how to the company is run, also known as 'articles of association'
This is one of the United Kingdom's most popular business structures thanks to its simplicity of operating, potential tax advantages and limited liability. With limited liability, the exposure to financial risk is within your control with a barrier between your personal assets and the company since these are separate entities. Your family, your home and your lifestyle remain protected.
As compared to a sole trader, the tax regime as a registered company is more favourable. Limited companies pay corporation tax on profits, with company directors taxed as employees. Any other profits generated after paying Corporation Tax are retained by the business. These profits can then be distributed to shareholders through dividends. Ltd can be limited by shares or by guarantee, which allows the controlling shareholder to decide on remuneration packages at discretion, protect the brand and claim expenses on the company.
Furthermore, annual accounts and financial reports have to be placed in the public domain, lending a high level of transparency and a significant advantage in conducting business.
This means that the paperwork involved can be a headache, but you can act as the sole shareholder, director and company secretary when it comes to the administration work. Appointing a company secretary used to be mandatory, but the regulations have since changed.
Jesse registers as a limited company. Due to the business's credibility, he was easily able to secure cash flow and witnessed huge profit margins as a result. His company has to pay corporation tax, while he is being taxed just like any other person working for the company. The remaining profits generated after offsetting Corporation Tax were retained by the company.
However, life is not a bed of roses. The turning point came when a competitor emerged in the market and caused Jesse’s business to plummet. Consequently, he was unable to keep the business going and had to wind up the operation. However, he gets to keep his personal assets including the house and the car, only losing his initial investment in the business.
When you've decided the right company structure for yourself, we’re ready to help you register your Ltd. business, simply drop us a chat. As you grow your business, we're here for you whenever you need someone to take over the mundane paperwork routine, show today's numbers, send reminders, and give active accounting advice.
Checklist and comparison table
|Sole trader||Sole business owner, entitled to all profits but also liable for the company's losses||
|Partnership||Two or more partners involved, sharing responsibilities of management and profits||
|Limited Liability Partnership (LLP)||Some or all partners have limited liabilities, with elements of partnerships and Limited Liability Company||
|Limited Company (Ltd)||Privately managed company with owners legally responsible for its debts limited to the amount of invested capital||