What are the Different Legal Structures in Business?
There are a few different types of legal structure your business can have. The aim of this post is to further your understanding of them and what effects they can have on the way that your business is run.
Remember: If you're still unsure about what to use after you've looked through this post then a solicitor or accountant can advise you on what best suits your need.
Becoming a Sole Trader
This is the most basic way that you can run a business. It's quick and simple to set up, there are no registration fees and you get to keep all the profits (after tax of course). Sounds like a win-win situation. However, there is a downfall with this model; you are personally liable for everything that the business does. Its mistakes are your mistakes. Its debts are your debts. This is why it can be risky setting up as a sole trader.
What about tax and national insurance?
Your profits are taxed as income. Also:
- you may have to pay fixed-rate Class 2 National Insurance Contributions (NIC) on the profits that you make above a certain level (currently £5,965)
- you may have to pay Class 4 NIC on any profits over a certain amount (currently £8,060)
- you will need to register for self assessment and complete a tax return every year
Keep in mind: because you are personally liable for the business' debts your house, and other assets, could be at risk if you fail to pay debt owed by the business.
I don't think being a Sole Trader is for me. What about a Partnership?
There are two main types of Partnerships: an 'ordinary' partnership and a Limited Liability Partnership (LLP). So what's the difference?
An 'ordinary' partnership cannot exist outside of the members of the partnership - if one of the partners resigns, dies or is made bankrupt then the partnership must be dissolved, but the business can continue to run as a different legal entity.
Think of this kind of business as being a sole trader but there's more than one of you running the business.
You should consider the following points:
- There is a nominated partner that must register with Companies House and they will have the majority rule over the business (exact responsibilities of the partners are set out by the Partnership Agreement).
- Partners are jointly responsible for any debts in the business and are equally responsible for paying them off.
- Creditors can claim one partner's personal assets to pay off a debt, even if the debt was caused by a different partner.
- If one partner leaves the partnership then the remaining partners need to pay off any debts caused by them.
- There is no limited liability in an 'ordinary' partnership.
I don't think I trust my potential partner to quite that extent. Is there another option?
Yes. There is a Limited Liability Partnership (LLP).
LLP's must have at least two designated members. The designated members will have greater responsibility placed on them by law.
LLP's will need to:
- register with Companies House
- send Companies House a confirmation statement (formerly an annual return)
- file accounts with Companies House
When Companies House receive the registration for the LLP, they will contact HMRC, who will set up the tax records for the LLP, meaning they will not have to register themselves.
A partner's liability is limited to the amount of money that they have put into the business. This means that there is some protection offered to partners if the business runs into difficulty.
What if I don't want a partner at all?
Then there's the Private Limited Company which may be an option.
A Private Limited Company can be limited by shares or by guarantee. A limited company must:
- Register at Companies House
- Notify Companies House if they have appointed a company secretary. The company doesn't need to have have one, but you may opt to appoint one.
- File its accounts annually with Companies House. These accounts must be audited unless the company is exempt.
- Send a confirmation statement (formerly annual return) to Companies House.
Private companies must have at least one member and one director, this can be the same person.
Each director must be an individual over the age of 16 years. They can also be shareholders and may be another organisation (check out our previous post on this here).
If the company is active then it must tell HMRC that it's trading, they will then be liable for Corporation Tax and submit a Tax Return.
The company exists in its own right. This means the individual directors are only liable for the company's debts up to the amount of money they have put into the company.
You can have a company that is limited by shares or by guarantee.
- If a company is limited by shares then the liability of each shareholder is limited to the amount outstanding for shares held by them.
- If a company is limited by guarantee then the members are only liable for the amount they agreed to contribute to the company in the event of it being wound up.
Shareholders can be individual companies or other individuals, but they cannot be offered to the general public.
What about tax and national insurance?
Directors must pay income tax and Class 1 NIC's on their earnings. This is because they are classed as employees of the company.
The type of business you want to set up is up to you. Hopefully this blog post gave you a little more information about the different types of legal structure you can have.
If you want to incorporate a limited company or an LLP, check out our packages here.
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