You’re ready to embark upon your new journey as an entrepreneur. You’ve got your idea, you’re raring to go – but what legal structure do you choose?
There are many different structures which businesses can operate in and it can be quite confusing! The four most common business models for a start-up like yours are registration as a sole trader, formation of a partnership, incorporation of a limited company and incorporation of a limited liability partnership (LLP).
What is a sole trader?
As an entrepreneur you can start trading immediately as a sole trader. A sole trader is self-employed and the profits earned are taxed as income by HMRC through the self-assessment. Although you will need to register with HMRC for self-assessment and complete a tax return each year, one of the biggest advantages is that there is no requirement for you to publish annual accounts or produce any other documents apart from the requisite self-assessment forms for tax or VAT purposes to HMRC.
As a start-up, the profits of the business may be small to begin with but this means the tax rates will be low. You will also be able to deduct business expenses (even if you work from home). However, if you do choose to become a sole trader, you need to be aware that you will be personally liable for the debts of the business. This means that in the event that a sole trader becomes bankrupt, your personal assets may be seized to pay off any debts owed.
Forming a partnership
Partnerships are very similar to acting as a sole trader. A partnership is formed when two or more people come together to run a business. It is usually governed by a partnership agreement but may arise from the normal course of business between two or more people. It is advisable to seek out legal advice to draft an agreement.
If you choose to set up a partnership, as with sole traders, you will be self-employed and are taxed on income through the self-assessment system with HMRC. You need to remember that on forming a partnership, liability is unlimited (as with sole traders) however all the partners will usually be jointly and severally liable for all debts of the business.
Incorporating a limited company
A limited company offers the most flexibility out of the four structures in this article. A company limited by shares is a separate legal entity, this means that the company can enter into contracts under its own name and can operate as a separate legal person. Therefore, your liability would be limited to the nominal value of the shares and your assets cannot be seized if the company goes bankrupt (subject to any personal guarantees given by the directors).
It is very straightforward to set up a company and only costs £12 to register with Companies House (£40 if you are sending a form IN01 in paper).
A limited company will have to comply with the Companies Act 2006. This means that a limited company will have to file accounts annually and a statement confirming the directors and shareholders of the business. Although you will have to meet this compliance burden, a limited company can be a very good choice for a start-up.
Incorporating a limited liability partnership or LLP
An LLP is a hybrid structure and includes some benefits of both a limited company and a partnership. As with a limited company, an LLP is a separate legal person and can enter into contracts in its own name. An LLP also enjoys limited liability (you won’t be personally liable) but with the addition of a favourable tax position afforded to partnerships. However, each member of the LLP is self-employed and taxed on his share of the profit.
In order to incorporate an LLP you need at least two members and is usually governed by a Limited Liability Partnership Agreement.
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