What is the Best Way to Structure my Small Business?

Choosing the best structure for your new small business is often one of the first things to figure out as a business owner. It is the most important decision to make, but is often overlooked. There are a number of different structures for businesses, but we will be focusing on the three most common business legal entities – limited company, sole trader and partnership. Some of the other types of legal entities are limited liability partnerships (LLPs), franchises, community interest companies, offshore companies. We have written a guide to LLPs which you can look at here.

We will first look at the different business structures that are worth considering, and then explain some of the key things to help you decide on which structure to go with.

Sole Trader

First up we have sole trader. Running a sole trader business is also known as being self employed, freelance, contracting etc. Sole traders register as self employed with HMRC and pay income tax on their business profits. This is the most simplest business structure, and is one we often recommend to those starting out in business. Tax is paid according to the income tax rates. Whilst running a sole trader business, assuming you reach the relevant thresholds, there is also National Insurance to pay on profits. Sole traders can register for VAT, and also register as employers on a PAYE scheme.

Advantages: The only statutory requirement of running a sole trader business is to ensure you are registered as self employed with HMRC and submit a self assessment tax return. This can be done by yourself or by an accountant. Your financial year runs in line with the tax year (6th April to 5th April the following year.) All profits are yours to keep. To close down a self employed business you need to inform HMRC that you are ceasing your trade and file a final self assessment. There are no additional costs to close the business.

Disadvantages: As a sole trader, the business and the individual are the same legal entity. This can mean that if your business gets into trouble and can’t pay its debts, you will be responsible for covering these. Another disadvantage is that for some businesses, it can be difficult to get work as a sole trader when working with larger corporate entities as they often like to ensure the protection of their self employed workers via limited companies. If you breach certain thresholds, or work in certain industries, you may also require an audit.

Limited Company

A Limited Company is the next on our list of popular business structures to consider. A limited company is registered at Companies House. There are shareholders, directors and persons of significant control. They can all be the same person. A limited company is a separate legal entity to you, the business owner.

Advantages: The main advantage of a limited company is that the business’ finances are separate to your own. If the company becomes insolvent for any reason, this is kept separate from your own personal financial affairs. Limited Companies pay corporation tax on their profits. Limited companies can be registered as employers and be VAT registered. Companies can be considered independently of the business owner for finance and investment (although personal finances are often taken into consideration in the early days of a small business). This means you can be clever with the timings of drawings from your business. If the business is profit making, you can pay yourself dividends (a distribution of profits) and pay these at different dates to make the most of tax efficiencies.

Disadvantages: On the other hand, running a limited company requires more administration than a sole trader. Accounts and Confirmation Statements are filed to Companies House and a Corporation Tax return is filed at HMRC. Whilst it is not a legal requirement to appoint an accountant, it is highly recommended as preparing accounts and corporation tax returns is a lot more complicated than it seems. (Accountant fees for limited companies are usually significantly higher than for a sole trader business). Accounts published to Companies House are in the public domain so if you don’t wish for competitors, customers or suppliers to view your financial performance, this may not be suitable for you. Closing down a limited company is also a relatively complex and long-winded process.

Partnership

There are two types of partnership – normal partnership and Limited Liability Partnership (LLP). We are only looking at a normal partnership in this article. We have written a separate guide to LLPs. A normal partnership consists of two or more sole traders working together. The partners are taxed as sole traders via Self Assessment based on the profits of the partnership, and in accordance to their profit share agreements. All partners are responsible for the finances of the business, although one is normally designated as the main partner. It is recommended that a partnership agreement is in place, although it is not legally required.

Advantages: One of the key benefits of a partnership is that you are sharing the burden of running a business with another person. If one of you falls sick, the business can continue. Generally with two or more people involved in a business, you are likely to be able to obtain extra funding and finance if required. You can add or remove partners at any point, as long as there is a minimum of 2 in the business.

Disadvantages: all partners are jointly liable for the business. Breakdown of the relationship between partners can often cause messy situations requiring the closure of the partnership.

Things to consider when choosing business structure:

• Do you need to spend all the profits that your business generates?
• Do you plan to bring anyone into business with you? (including family members)
• Is your business high risk and likely to become insolvent?
• Are you unsure of how long you want to run a business for? Might you need or want to close it down in the near future?
• Will you be building up large cash reserves in the business?
• Do you want to protect yourself from potential business liabilities?
• How much am I willing to pay for support to run my business?
• Do you want to obtain investment and/or sell shares in the future?
• Do you want flexibility over the decisions made in your business?

The above considerations are just some of the common ones – if you are thinking of setting up a business, it is always best to seek the advice of a professional as to what should be considered. In recent years, looking at tax efficiencies as the sole comparison will not be sufficient to give you the best option, and the wider picture needs to be considered – longer term plans, scalability, requirements for personal funds etc are bigger considerations. Plus tax rates change all the time and cannot be relied upon.

If you’d like to discuss with us the best business structure, how to get set up, and how we can work together, please book in a Discovery Call here.