When you decide to set up in business, it’s very important to make sure you choose the right type of business structure. There are a number of issues to take into account when you decide to set up in business, not least of which is your appetite for risk.
In this article we will consider the common business vehicles available to you and provide you with a brief overview of what’s involved in each.
We would say at the outset that the business structures we cover are not the only types of business structures available – there are some specialised business structures, but those types of structures are only used in less common scenarios.
The main types of business clients use are:
- Sole Trader
- Limited Liability Partnership
- Limited Liability Company
We should also say that we are looking at these options from a Scottish perspective (although much of what we say will apply to England, Wales and Northern Ireland).
As the name suggests, this is the most basic form of business. You set up your business and you own it yourself. Perhaps it can be a misleading title because many sole trader businesses employ several people. The main focus of a sole trader business is that it has only one owner.
When you operate as a sole trader, all of the assets of the business will belong to you and you will also be responsible for the liabilities of the business. This can be risky because if you run into trouble and can’t pay your debts, not only do you stand to lose your business assets, any personal assets you own can also be claimed by your creditors.
As a sole trader, you will be the decision maker. You decide what you do and how you do it and you don’t have to be accountable to anyone else.
You are taxed on the profits you make from your business and have to pay income tax based on those profits.
There is no need to publish any accounts. That means what you earn is between you, your accountant and the tax man!
If you set up a business with another person or other people, you might consider forming a partnership. There is less formality in setting up this kind of business than there is when setting up a limited company but whereas you can make all of your own decisions as a sole trader, in a partnership, you need to consider the views of the other partner or partners.
The partners in the business, in Scotland, own all the assets of the business. Partners in a partnership don’t have to have equal shares and that means that the participation in profits can vary depending on the percentage ownership of the business. There are situations in partnerships where some partners are active in running the business whilst others (sometimes the ones who have put up the money) are “silent” partners who don’t get involved in running the business.
There is the possibility of a category of partnership known as a “salaried partner. This person, whilst being called a partner, does not have any right of ownership in the business.
You should always have a written Partnership Agreement which will not only set out the structure of the partnership but will also deal with what will happen if the partners decide to terminate their business arrangements – either amicably or otherwise. If you don’t have a written Partnership Agreement, you then need to rely on the provisions of the Partnership Act 1890 – not the most modern by any stretch of the imagination!
From a liability perspective, partners fall into the same category as sole traders when it comes to liability. If a claim is made against the business, the creditor making the claim can also attack the assets of the individuals as well as any partnership assets.
The partners in the business are taxed in a similar way as sole traders, based on their share of the profits earned from the business. As with sole traders, there is no need to published accounts.
Limited Liability Partnership
A limited liability partnership operates in a similar way to a Partnership but has the benefit of limiting the liability of the partners in the same way as the liability of shareholders is limited in a limited liability company. As the name suggests, there needs to be more than one person before a limited liability partnership can be formed.
There are formal requirements to registers the limited liability partnership with Companies House and to publish accounts (albeit abbreviated versions) and file returns on an annual basis.
The partners in the limited liability partnership have a right to run the business and they own the business.
If a claim is made against the business, the partner’s personal assets are usually shielded from the claims of creditors and only business assets can be recovered.
From a taxation perspective, the profits are taxed in the same way as a partnership – in other words, the partners are taxed on their share of the profits and the actual Limited Liability Partnership isn’t taxed at all.
Limited Liability Company
One of the main features of a limited liability company is that there are two key component parts. There are the shareholders (or members) who own shares in the company and there are Directors (or Officers) who are the people who run the company.
The shareholders don’t have to be directors and directors don’t have to own any shares in the company they run.
The company has to have at least one director who is responsible for the day to day operation of the business.
The liability of the shareholders is limited to the amount of money they’ve put up to buy shares in the company. If they’ve paid for all of the shares they own, that means if a claim is made against the company, the creditor can’t get any more money from the shareholders. If, however, the shareholders haven’t paid all that they should have paid for their shares, the in the event of a claim that causes the business to go into liquidations, they will need to pay what they owe to the company for the shares they own – but not a penny more.
From a taxation perspective, Limited Liability Companies are taxed on the profits they generate. This tax is called corporation tax. Directors in the company who are employed, will pay regular PAYE whilst shareholders who receive dividends will be taxed on the money they receive from dividends based on the taxation regime in force at the time.
This form of “double taxation” sets limited liability companies apart from the other types of business entities discussed above.
If you would like to discuss any aspect of your business structure or, if you’re setting up in business and would like some advice, please contact us.