Which legal entity is right for your Business?
When you are thinking about setting up in business, you need to decide the right business entity (structure) for your needs.
Which legal entity you chose will determine what legal responsibilities you will take on, for example:
The paperwork needed to get started
The taxes you will have to manage and pay
How you can take the profit the company makes
Whether you have personal liability for then debts of your business
“Choosing the right legal structure needs careful thought and is about more than money. Initially we would always ask the longer term goals and who is going to be involved. It is easier, for example, to arrange the sale of a Limited company if you know you are going to want to exit. Some people also are thinking about a social enterprise model and that is more complex.”
The main types of business are:
Limited Liability partnerships, unincorporated associations and social enterprises are 3 other types of business, however for the purpose of this blog, we will concentrate on the main 3.
When you start working for yourself, regardless of whether you’ve informed HMRC or not, you are classed as a self-employed sole trader.
Sole traders keep all the profits the business makes after tax has been paid on them, and you own the business as an individual. Sole traders are personally responsible for any loss or debt the business may find itself in, and for any claims from customers or clients (such as claims for breach of contract or negligence).
As a sole trader you can employ staff.
As a sole trader you have to send in Self Assessment tax returns, pay income tax on any profits the company makes, pay National Insurance and if you expect to make more than £82,000 a year you must register for VAT.
If you are setting up as a sole trader, read the government’s guidelines here.
If you join together with one or more other people to run a business for profit, then it is likely that you will have formed a partnership. Just because you have not signed a partnership agreement, that does not mean you will not be in a partnership.
Like sole traders, partners keep all of the profits the business makes after tax, and each partner owns a part of the business as an individual. By default, the profits and business are split equally between the partners, but you can vary this if you wish.
Partners are personally liable for the debts, losses and liabilities of the business. Importantly, partners are liable even if the debt or liability has been caused by one of the other partners.
Partnerships can employ staff, and all of the partners will be the employer.
Tax and VAT is largely the same as for a sole trader.
Partnerships are different to Limited Liability Partnerships, which I have not covered in this blog.
A limited company is its own legal organisation, separate to the person starting it. The company has responsibility for everything it does and all the finances.
The company owns the profit it makes after paying corporation tax which it then shares out.If you own a company, you will probably pay yourself a basic salary each year, and receive dividends from the company to top-up your pay. You will pay income tax on your salary and dividends.
A limited company is owned by its members. Directors can either be shareholding or non shareholding directors
The responsibility of being a director is wide and varied, as is running a limited company, I recommend you read the governments guide and discuss it with your growth coach / accountant to see if this is right for you.
If the company ceases trading, gets into financial difficulty or incurs a liability to customer or client, then (with the exceptions below) the directors / shareholders are not personally liable (although they could lose any money they have put into the company, either as a loan or for shares). This is referred to as “limited liability”.
The main exceptions to the limited liability rule are:
some banks and lenders will ask directors or shareholders to sign personal guarantees, making them personally liable for the company’s debt to the bank.
as a director you must comply with certain rules (e.g. acting in the best interests of the company, and not trading when the company is insolvent). If you breach those rules, you could also be personally liable to creditors or the company.
if you, as an individual, are providing advice or guidance to customers, you can (in some cases) still be personally liable if the advice you give is negligent.
A limited company can employ staff.
As a limited company, every financial year, the company must:
The company must register for VAT if you expect its takings to be more than £82,000 a year.
If you’re a director of a limited company, you will usually need to:
fill in a Self Assessment tax return every year
pay tax and National Insurance through PAYE if the company pays you a salary
Limited companies can be perceived to be larger than Sole traders, but this isn’t necessarily the case.
Being a limited company has the benefit of limited liability. It is also possible to place life insurance and critical illness cover through your business and claim full corporation tax relief on the premiums, which may be preferable to paying for your personal life insurance out of your post-tax income. If you want to investigate this further many financial advisers can assist you, I use Business Protect.
“There are 2 things I recommend people think about when they’re deciding how to set up their business. Firstly, how good is your financial management? Because a limited company has to submit annual accounts they will need to work with an accountant. While that involves an additional cost it also makes sure that the business’ finances are in order. Sole traders have much more flexibility with their accounts but that can mean that the line between personal and business finances becomes blurred and it’s possible to run a business that’s making a loss without even realising it.
The second factor is the intriguing question of perceptions – both your own and your customer’s. Customers may feel that they’re dealing with a more serious business if that business is limited. Have a look at the type of customer you’re dealing with (or are going to be dealing with). If they’re mostly larger limited companies themselves then they may take you more seriously if you’re the same. Then again if you’re dealing with the general public who are unlikely to take this into consideration it’s less important. Think also about your own perception too. Would running a limited company make you feel more professional? Would you be more confident about marketing your business if it was limited? Or would it not make the slightest difference to you? Plenty of juicy stuff to think about!”
Whichever business legal entity you decide to take, make sure you get advice from professionals and do your research, this blog is for guidance only and shouldn’t be seen as legal advice.
Many thanks to Andrew Cooper from Greeene & Greene for reading through this article for me, really appreciate your help.