A proper business structure can make the difference between a successful and failed company. In this blog, we will discuss the different types of business structures, and hopefully, help you decide and give you an insight into which one is best for you.
Here is a quick summary of the business structures we will be discussing:
- Sole traders
- Limited Liability Partnerships (LLP)
- Limited companies
What is the purpose of a business structure?
A company’s structure identifies who owns it, how it should pay income taxes, how earnings are dispersed, and which management is in charge of what. For tax and liability purposes, a clear and legally recognised corporate structure is required; the business will be taxed differently, and managers/owners will be personally liable to varying degrees in the event of misconduct or a lawsuit.
Business Structures Explained
A sole trader is a person who is the exclusive owner of a business, entitled to keep all profits after tax has been paid, but liable for all losses. As a sole trader, you have entire control over your firm.
You can form a partnership if you have one or more partners who are also responsible for the business. The profits are split among the partners, who each pay tax on their share. The partners, like a sole trader, are accountable for business debts.
However, with a partnership, it is essential you properly comply with legal requirements to help you deal with and avoid future business issues. It is a good idea to record everything officially and in writing in a partnership agreement, once everything is filled out and agreed upon.
Before starting a business partnership, here is what you need to consider:
- Each partner’s ownership share
- How decisions will be taken during meetings, and whether or not any partner will have a casting vote or more say on a certain issue
- The process of bringing on a new partner
- Who puts what into the partnership, and whether or not those assets belong to the partnership
- if the company is sold or wound up later
- How will profits and losses be distributed?
- The authority boundaries of each partner who makes independent decisions, such as agreeing that no partner can borrow or place an order of more than £500 without the consent of the others
- The process for removing a partner from a relationship, or what happens if a partner wishes to depart
An ordinary partnership is made up of two or more persons who work together to run a business. Under this process, you must still select whether or not to trade under a business name and, if so, what the name should be. There are also some restrictions on the names you can use.
Companies House registration is one piece of paperwork you can skip. An ordinary partnership does not need to be registered with Companies House – the way you operate your company is a private matter between you and your partners.
When forming an ordinary partnership, it is critical to designate a nominated partner who will be in charge of registering the partnership with HMRC. This person is then in charge of keeping the company’s records and filing tax returns.
All partners must register for HMRC for self-assessment.
Limited Liability Partnership (LLP)
A Limited Liability Partnership allows for a partnership structure where each partner’s liabilities are limited to the amount they put into the business. In an LLP, one partner is not responsible or liable for the misbehaviour or carelessness of another partner.
The partners’ responsibility in a partnership is unlimited. That means that if a partner is careless, legal action can be taken against them. If the identical task is contracted to a Limited Liability Partnership, no blame may be assigned to the irresponsible partner because a district legal company has been created.
Employees may or may not be members of a Limited Liability Partnership. This is frequent in professional service firms with both salaried and equity partners (workers who are entitled to a percentage of the firm’s profit as a bonus under their employment contract and members who share in both the profit and losses of the partnership).
Two types of Partners in a Limited Partnership business structure:
- General Partners: these business Partners are not subject to any limitations on their liabilities
- Limited Partners: these company Partners are only liable for a certain amount of money
A limited business is sometimes characterised as a General Partner. The benefit of doing so is that, while the company’s obligation as a Partner is infinite, its shareholders’ exposure is limited. One thing to keep in mind is that this structure may require more administration for small businesses than the added safety is worth.
You should choose a business name and agree on terms in a formal LP agreement, just as you would for other forms of Partnerships.
A limited partnership, like an LLP, is registered with Companies House. You can do so by completing Form LP5: https://www.gov.uk/government/publications/apply-for-a-registration-of-a-limited-partnership-lp5
Each partner, like other types of partnerships, must register for self-assessment with HMRC separately.
Limited Company (Corporation)
A Limited Company is a private company whose owners are legally responsible for its debts only to the extent of the amount of capital they invested. When you form a corporation, you’re forming a separate entity from your personal money, which is not the case with sole traders or partnerships. This separation has a number of advantages, including:
- Funding: a limited company makes it much easier to raise capital, and multiple classes of shares allow you to provide investors varied dividend rights and levels of influence over the company
- Limited Liability: unless you’ve signed a personal guarantee, your assets aren’t harmed if the firm runs into financial difficulties
- Corporate tax rates are lower than the highest personal tax rates, resulting in tax efficiency – when profits reach a particular level, a limited liability structure permits you to pay lesser taxes than if you were a single trader or a partnership
When a firm wants to go public by issuing common stock to the general public, it must first be formed as a Limited Company. The ability to raise capital is one of the benefits of a Limited Company business structure. The entity can raise enormous sums of money by selling stock to the general public. In addition, the limited company business form comes with Limited Personal Liability, which protects the owners of the company from debts, liabilities and duties.
Company directors have additional obligations in incorporated structures. Directors must follow the Companies Act of 2006 and use reasonable care, skill, and diligence. Directors must also operate in the company’s best interests rather than their own. Limited Companies, more than a sole trader or partnership, are also needed to keep meticulous records. This is the director’s obligation and if they fail to do so, the director may be held personally liable for this.
When is it time to form a Corporation?
Starting a business as a sole trader is usually the simplest option for many first-time entrepreneurs because it is relatively easy to set up. When a single trader’s business grows and profits are reasonable, they may desire to incorporate. At this point, there is obviously more risk, and incorporation can help to protect personal assets. Incorporation can also help you to save money on taxes. Because there are so many variables to consider, it’s best to seek advice from a specialist.
How do you form a Corporation?
You can incorporate your company at any time, by submitting an application to Companies House. It is usually a quick process – most businesses can incorporate it in less than 24 hours. However, if Companies House opposes or requires additional information from the applicant, it may take longer.
You can submit your application here: https://www.gov.uk/limited-company-formation/register-your-company
You can also apply online using the Companies House Web Incorporation Service if you are not a public company.
Incorporation fees range from £30-£200, depending on whether a business owner handles things themselves or employs a professional. Some companies hire a formation agent to guide them through the process and manage the paperwork. Having a trustworthy agent handle the procedure guarantees that all paperwork is completed accurately.
‘Fiscal Year’ of your company
Due to a company being a distinct legal body, it will have its own fiscal year, which will begin on the date of incorporation. Because there are other “years” that come into place when performing accounting and tax planning, such as a personal tax year (6th April through 5th April) and the corporation tax year (6th April through 5th April), this financial year might generate some complications (1st April to 31st March). Many organisation connect their financial year-ends with tax year-ends to make things easier, allowing you to finish all accounting, payroll, and tax work at once, rather than spreading it out over the year. However, because things can get complicated, a professional advisor can assist you in ensuring that you have the finest arrangement in place.