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Choosing a legal structure for your business

Tuesday, 20 September 2016

hand-427518_640One of the most important decisions you have to make when setting up a company is the type of legal structure that you wish to operate under. It is important to have a good understanding as each option has its own specific advantages and disadvantages relating to a number of areas including tax, liability and finance. Here we will go through each of the three most popular forms of business structures and detail the pros and cons.

Sole Trader

The easiest structure to get your head around, a sole trader is normally the most suitable business structure for small businesses. As a sole trader you solely own and control your business and are liable for it. In the UK the majority of businesses operate as sole traders. Some examples include butchers, barbers, photographers and plumbers.

The pros of running a business as a sole trader are numerous. First of all you maintain control over key decisions regarding your business which means you don’t have to win anyone around to your way of thinking. There are also very few costs to setting up as a sole trader when compared with other structures. Normally a sole trader will either have no, or very few, employees so do not have to worry about the legal obligations of employing staff.

Operating as a sole trader is not without its negatives though. Under the eyes of the law, the owner of a business operating as a sole trader and the business itself is not separate. This means that if your business encounters problems, you are responsible, as you have unlimited liability. So, any debts the business owes are ultimately coming out of your pocket. While working self-employed and running your own business can give you lots of freedom in decision making, it also means that you may often have to work unsociable hours and may have to save capital, or take out insurance in the event of illness.

Partnership

A partnership is when two or more persons come together to form a business, often people with differing skill sets that combined can help propel a business forward. Business owners of a partnership share both the profits and the liabilities of the company. Decision making may also be shared but it is critical to have a “deed contract” drawn up by a solicitor to outline all aspects of the partnership helping to avoid conflict further down the line. Some popular examples of partnerships include Warner Bros, Hewlett Packard and Microsoft.

Forming a company as a partnership allows people with different skills and personalities to contribute to a business and both profit from the results. This means that if one person is particularly good at logistics and administration then they can concentrate on that aspect of the business, whilst another could concentrate on sales and bringing in new business. Co-founding can also help to relieve some of the pressure that comes with being self employed, allowing you to take time off and know that the business remains in capable hands while you are gone. A partner may also allow extra capital to be introduced to the business and to share the burden of their unlimited liability.

However, the fact that, like a sole trader, you are both responsible for the company’s debts and liabilities, can often create hostility between partners who may question each other’s decision making when things go wrong. Conflicts can also arise over distribution of profits and other aspects of running the business which is why it is important to think carefully over the details of your original deed and to revisit it whenever necessary to keep everyone happy. Like a sole trader, you are also both required to submit a Self Assessment tax return to HM Revenue & Customs each year.

Limited Company

An alternative to sole-trader and partnership company structures is that of a limited company. A limited company is an organisation created to run your business, which exists in its own right and is separate from your own personal finances.

A limited company has benefits both in taxation and legal status and it can even allow you to win more clients. Becoming a limited company allows for the owners of a company to take home profits from the business at a reduced rate and dividends are not subjected to national insurance deductions.

Limited companies are run by directors and funded by shareholders, which could be the owners, employees or the general public. Opening up your company to outside shareholders allows for more capital to be raised, without the risk to your own personal finances. As the company has its own legal status, your own personal possessions and finances are protected from being used to pay off company debts.

Limited Companies are often viewed as more trustworthy than partnerships and sole traders and some suppliers and customers may even refuse to work with you if you are not registered as a limited company. One disadvantage of running a limited company is that there is a number of administration costs incurred when setting up and there may also be greater taxation and administration costs incurred too.

For many businesses just starting out setting up as a sole trader or a partnership in the beginning may well be the most effective route, as you can always transition into a limited company at a later date. However, this depends entirely on the nature of your business and your particular needs.

Here at Rollingsons we pride ourselves on building long-term relationships with our business clients, helping them through the process of setting up a business. If you wish to speak to one of our experienced employment law team and would like to arrange an initial consultation then please call us on 0207 7611 4848 to arrange an initial consultation, or click here to read more about our team.

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