That Light bulb Moment: Choosing the right business structure for your start-up
There are several business structures available to start-ups and choosing the right one should be at the top of your agenda. This decision will affect the level of control you have over your business, dictate the amount of tax payable on profits, and govern your responsibilities and liabilities if the business makes a loss or, worst case, fails.
The most common business structure for start-ups in the UK is a private company limited by shares. However, this may not be appropriate for all businesses. Other common options include sole traders, partnerships and limited liability partnerships. Before deciding which structure is most appropriate, founders should consider the following questions:
- Are you setting up a business on your own or with a co-founder?
- Have you considered the rate of tax payable in relation to each business structure?
- What is your attitude to risk?
- How much information are you prepared to disclose to the public?
- Does status matter?
- What will future investors expect?
Becoming a sole trader is the simplest way to register a business. It involves minimal set up costs and allows the founders to retain full autonomy of their business. Importantly, there is no distinction between the founders and the business, meaning that the founders bear all the legal and financial responsibility and risk. Sole traders are considered self-employed and are therefore required to register with HMRC for self-assessment as soon as they start trading.
There is no requirement to register the name of the business and founders may trade under their own name or choose another name. They are not required to file annual accounts with Companies House, but they must keep records of their business’ sales and expenses, send a self-assessment tax return every year and pay national insurance and income tax on any profits. If the turnover of the business reaches over £85,000, they will also be required to register for VAT.
In return for keeping profits after tax, the founders assume unlimited personal liability for the business’ losses and debts.
Being a sole trader can make raising finance difficult. Unlike a limited company, a sole trader bears the full financial liability for the company on a personal level and this may mean that traditional lending avenues are unavailable. This will also be exacerbated by any poor personal credit rating.
When there are two or more founders wishing to carry on a business with a view to making profit, they may go into partnership and personally share the responsibility of running the business. Each partner will pay tax on their share of the business profits by registering with HMRC as self-employed. The partnership must also be registered with HMRC and file annual tax returns. A partner may be an individual person or a legal entity, such as a limited company.
Founders who use this business structure should enter into a written partnership agreement to govern, amongst other things, the extent of each partner’s liability for business debts and the proportions in which they own the business and share the profits. To the extent that certain matters are not addressed in a partnership agreement, the Partnership Act 1890 shall apply.
Partnerships are easy to form, manage and run, and there is no legal obligation that they keep detailed records or publish annual accounts. However, as the business grows and takes on greater borrowings, the potential for significant losses and liability also increases and it is not uncommon for creditors to require Personal Guarantees for the debts of the partnership. Founders must be mindful of their unlimited personal liability for any debts and losses of the partnership.
Limited Liability Partnership (LLP)
LLPs, which are incorporated and registered at Companies House, are separate legal entities. This business structure therefore protects founders’ assets by limiting their liability to the value of their shares. They are widely recognised as a halfway point between a general partnership and a private limited company.
LLPs must make filings at Companies House, and their accounting and filing obligations are largely aligned with those of limited companies.
LLPs must also be registered with HMRC and, as with a general partnership, any share of profits between members will be taxed as income. Therefore, each member will also register individually with HMRC as self-employed. In addition to that, the LLP must be registered for VAT if business sales exceed £85,000 a year.
LLPs are typically governed by a members’ agreement which manages how the profits are shared among members, who is responsible for making decisions, outlines each member’s day-to-day responsibilities, and directs how members can join and leave the LLP.
Founders may find comfort in this legal structure as it has the combined benefits of a general partnership, being flexible in the way it operates, and a limited liability company providing limited liabilities to its members. However, if you are a single founder this business structure is not possible as it requires two people to set it up.
Unlike private companies, LLPs do not have a share capital and cannot receive investment for a stake in the partnership.
Private Company Limited by Shares
These are the most common form of private companies and are a popular option for founders to launch their start-up companies.
Private companies limited by shares are separate legal entities from their owners and managers, and they limit each shareholder’s liability to the amount that they have invested, meaning that shareholders’ personal assets are protected in the event of company insolvency.
Profits made by the business will be subject to corporation tax. Any profit made after tax can be distributed to the shareholders in the form of dividends.
Limited companies require at least one director to manage the day-to-day business of the company and at least one shareholder. These can be the same person. Directors have several statutory duties to remain compliant with.
Companies must submit accounts and other information at Companies House. This includes the company’s constitution, annual accounts, confirmation statements and details of legal charges, for example. Certain details of the directors and persons with significant control will be available in public records at Companies House.
The company’s constitution contains regulations and byelaws for the internal administration of the company and, amongst other things, defines the powers of the directors and other officers of the company. On incorporation of a company, either default model articles or bespoke articles can be adopted. The constitution can be amended in the future with authorisation from the company’s shareholders.
Overall, this business structure creates a professional image for the business and enhances the founders’ investment and lending opportunities. It also provides founders with invaluable financial protection by minimising their personal liability.
Based on the above, it is clear that choosing the right business structure is a crucial step in starting a business. It is typically heavily influenced by tax considerations, and you should seek tax advice before committing to any structure.
The decision will also have financial, legal and operational implications, and it is therefore important that you take legal advice on these options. The Banking and Finance team at Greenwoods GRM is on hand to advise you on the most suitable structure for you and to continue to support your business going forward.
Before incorporating a company at Companies House, you will need to carefully consider:
- Is the proposed company name used or protected by another entity? You can check this using the Companies House name availability checker service. Be aware that a company name is not afforded automatic trademark protection. Separate searches of the trademark register will need to be performed.
- Will the directors’ residential addresses be made publicly available, and how can this be avoided?
- How many shares should each co-founder subscribe for?
- What classes of shares should co-founders be issued?
- What should be the nominal value of the shares?
- Are model articles of association sufficient?
You will also need to prepare Statutory Books detailing your directors, members and share capital.
Take time and care in considering which business structure is best for your business. Changing the structure at a later date may not be straightforward and may be a costly exercise.
We can discuss the intricacies of each business structure so that you adopt a structure that best suits your business needs and requirements.
We can also incorporate your company quickly and efficiently, prepare the company’s statutory books, make you aware of your ongoing rights, obligations, responsibilities and, if necessary, assist with ongoing filing requirements at Companies House.
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