The legal structure of your business will have a profound effect on the financial and legal realities of its day-to-day maintenance and administration. It will affect everything from the records you need to keep to the type and amount of tax you pay. Crucially, the legal structure of your business will also determine how much personal liability, if any, you would assume in the event that your business encountered financial difficulties. For all of these reasons, it is vital that you make the right decision.
New business owners are faced with a choice between several legal structures, and it is important that you understand the characteristics of each before making a decision
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Your accountant will advise you the most suitable structure for your business. It is generally a good principle to start out with the simplest structure your business plan will allow, as you can easily change to a more sophisticated model as the business scales up. The three main types are Sole Trader, Business Partnership, or Limited Company.
If you work for yourself, you’re classed as a self-employed sole trader – even if you’ve not yet told HM Revenue and Customs (HMRC). As a sole trader you run your own business as an individual. You can keep all your business’s profits after you’ve paid tax on them. You can employ staff. ‘Sole trader’ means you’re responsible for the business, not that you have to work alone.
However, operating as a sole trader requires a trade-off. While you will avoid the significant administrative demands that are placed on the directors of limited companies, you assume complete liability in the event that your business fails. As a sole trader there is no separation between your business and personal assets, and you can be personally bankrupted by the failure of your venture. As such, depending on the size of your debts, as a sole trader you should be prepared to lose your home if your business collapses.
It’s when the business starts to grow that the problems of being a sole trader may emerge and your accountant may advise that the time has come to adapt your business structure to either a Partnership or a Limited Company.
Like a business operated by a sole trader, a partnership is not considered a separate legal entity. Rather, the two or more partners involved assume the same responsibilities as those taken on by a sole trader, but the liabilities are split between them. The partnership will have to submit accounts to HMRC, in addition to the self-assessments submitted by each individual partner.
Limited Liability Partnerships are a sensible choice for those who value the flexibility of a traditional partnership, but want to be insulated as far as possible from potential liabilities.
Under an LLP arrangement, each partner’s individual liability is limited to the total sum that they initially invested. Partners cannot be held liable for any debts run up after that point, unless they have provided personal guarantees against any such debts.
As in a regular partnership, each individual partner must submit their own self-assessment to HMRC in addition to the accounts submitted by the partnership itself.
If you decide to go down the route of becoming a Limited Company you will be reducing your personal exposure to financial risk, because a limited company is a separate legal entity to the company directors, therefore it is the business itself that shoulders the financial liability if the business goes under.
Discuss the different options with your financial advisor, they have the appropriate expertise to steer you and your business safely through.