Tips to Choose the Right Structure for Business
As you may already be aware, there are various different structures that your business can adopt. This will mainly be chosen when setting up the business, but can be changed later if necessary. Even so, this is an important decision and shouldn't be taken lightly, the type of structure chosen can impact how your business is owned, run, how much tax will have to be paid, how much personal liability the owners will hold and more.
Some people who want to start out in business seek advice from experts in the field before taking the plunge. However, this post aims to highlight some of the most popular business structures along with some of their pros and cons in order to better aid your decision.
Business Entity Types
The type of business entity chosen will mainly depend on three significant factors. They are taxation, liability and flexibility required. In order to further explore these, let's take a look at the main structures.
Sole Proprietorship (Sole Trader)
This is a business operated by an individual, it is quick and easy to set up with minimal form filling. There are a few points to note here:
- Sole proprietorship is considered to be part of an individual rather than a separate entity.
- The profits and losses are included on an individual's personal tax return.
- The individual retains personal liability for all legal matters and business debts.
As you can see there are a few things to take into consideration, such as individual tax returns and the main sticking point which is any business debt is also your personal debt. What does this mean? If your business runs into financial difficulty, you could end up losing personal assets such as your house or car in order to pay off the debt, which could also lead to personal bankruptcy.
A partnership (or in full - unlimited business partnership) is almost the same as multiple sole traders working in the same business. Each member is an individual and gets a share of the benefits and profits, but also the risks.
You can share all the profits between the partners. Each partner pays tax on their share of profits. The partners remain responsible for:
- Losses incurred by the business
- Bills for the things a partner buys for business, like equipment or stock.
Private Company Limited by Shares
This is the most common trading model for UK based businesses. It can consist of a sole director and shareholder or multiple directors and separate shareholders/investors. A limited company is a separate legal entity to that of its owners and all legal and financial obligations are met by the company with the directors and shareholders incurring limited liability.
In other words, if the company runs up debt, it's the responsibility of the company to pay it and not the individual members.
Private Company Limited by Guarantee
A Limited by Guarantee Company is the typical model adopted by non-profit organisations such as sports clubs and charities. This type of company has no share capital, and consequently no shareholders. Instead the members of the company guarantee a nominal sum of £1 to the company and this is the extent of their liability.
A key provision for Limited by Guarantee companies is that the profits generated must always be reinvested into the objects, as defined in the company's Articles of Association. This prevents members of the company from extracting profits for their own personal gain.
Limited Liability Partnership (LLP)
A Limited liability partnership can be set up for running a business with two or more members. Here, the members can be both a person as well as a company. Each member has to pay tax on their share of profit as it is the case in ordinary business partnerships. However, they are not personally liable for any debts the business fails to pay.
Tips to Decide on the Right Business Entity
While taking a decision on the type of business to form, you need to evaluate different criteria. We've taken a look at some of these below.
Find out the extent to which your business needs to be insulated of legal liabilities. Are you ready to take on the personal liability for the potential losses associated with business? If you cannot, its better not to opt for partnership or a sole proprietorship. Remember that a director of a company has legal responsibilities too (find out more here).
On the basis of goals and the situation of the business owner, the options to minimise taxation should be considered. You need to choose a structure reflecting your tax, financial and administrative requirements. For example, if you are looking forward to raising capital and taking a business to the next level, sole trader structure may not be the best fit for you. An accountant or business advisor may be able to help you choose the best option to fit your business.
Your goal is maximising flexibility of ownership structure considering the unique needs of the business as well as personal requirement of the owner(s). Individual requirements are a prime consideration here - no two situations are the same; particularly if multiple owners are involved.
Deciding on the type of business entity and set up is not an easy job. Unfortunately, businesses are quite varied and there are no hard and fast rules regarding which structure would work and which would not. Make sure to consult an experienced and well versed professional while deciding on your legal structure. Remember, Company Wizard can help with questions related to some of these types too. Also, continually assess your business as it grows, since reviewing the structure can save you money.