How Do I Choose a Business Structure?

Once you choose a name for your business, it’s time to register it legally. This is an exciting part of the process, as you edge closer towards being open for business. But which structure do you go for? There’s no one-size-fits-all when it comes to this type of thing, and what works for a freelance copywriter might be less practical for a builder.

Because this is one of the first major business decisions you’ll make, we get that it feels daunting. Help is at hand though! Let’s look at each business structure, along with their potential pros and cons depending on your circumstances.

 

Starting up as a sole trader

If you register your business as a sole trader, you’re the sole owner of your business, with full autonomy to run things as you please. Hairdressers, graphic designers, copywriters, and electricians often choose this business structure.

Becoming a sole trader is a popular option as it’s easy to register, and the perfect transition into the world of business and tax.

What are the pros and cons of setting up as a sole trader?

Pros Cons

You have complete autonomy to run your business how you see fit.

It’s easy to set up and manage, and completely free to register. So, if this is your first business, it makes life a lot easier.

As you grow, there’s much more flexibility to change and switch to a limited company, so starting as a sole trader can be a more practical way to get your business going.

You keep 100% of the profits once you’ve paid your NI contributions and tax.

You’re completely liable for any debt your business incurs.

It can be harder to receive any funding as a sole trader business, because you are the business which makes the investment process more complicated, so most rely on their own savings or funding from family and friends.

It can be much less tax efficient in comparison to a limited company, depending on how much you earn and any other sources of income you might have.

If you plan to keep your business small, staying as a sole trader is most likely the best option – unless you’re in a high-risk industry, such as construction or accountancy.

Once you begin to grow it may be worth looking at options to protect you, your business, and to be more tax efficient with your profits.

 

For example: let’s say you start a clothing business as a hobby, with an intimate clientele. As your business grows, your clientele grows with it, and now, to keep up, you need staff and a larger working space. While you could hire staff as a sole trader, you’d still be dealing with much larger sums of money and a higher risk of liability if things go wrong.

 

In this example, moving from a sole trader structure to your own limited company would make more financial sense, not only in terms of liability but for tax efficiency too.

 

Bottom line:

Registering your business as a sole trader is a good option if your business is low risk with low profits. This is because you’re completely liable if anything goes wrong and being ‘liable’ means any business debts will fall on you.

Having said this, it’s ideal if you’re looking to stay smaller – or you’re just starting out – as you can keep all your profits once you’ve paid tax and National Insurance.

Starting up as a limited company

Unlike a sole trader business, a limited company is legally separate from the people who own or run it (known as shareholders and directors).

Registering a limited company is slightly more complex, as you’ll need to incorporate your business with Companies House. Because you and the business are separate entities, you’ll pay Corporation Tax on behalf of your company while also submitting Self Assessments to declare any income you take from the business personally.

The ‘Ltd’ or ‘Limited’ you use at the end of your company name is what gives the business ‘legal personality’ and you ‘limited liability.’ In other words, if your company ever comes into debt, losses, or has any legal claims against it, your personal assets are protected because they’re yours, not the company’s.

 

What are the pros and cons of setting up as a limited company?

Pros Cons

Limited liability – this means you’ve reduced your exposure to financial risk.

Some people feel that a company has much more credibility, which can help with things like funding, or pitching for work.

It can be more tax efficient. For example, you can give yourself a smaller salary below the tax and NI threshold and pay yourself the rest in dividends.

Forming a company costs money, unlike setting up as a sole trader.

There are more admin and reporting requirements than if you were a sole trader.

Your business records are publicly available, which means any investors or competitors can view your financial statements.

 

Bottom line:

A limited company is ideal if your business poses a higher financial risk, and you want to protect yourself whilst being tax efficient.

While this all sounds great, it’s worth mentioning that start-up fees and accountancy fees are usually higher for companies!

Starting up as a business partnership

A business partnership is exactly how it sounds. You and your partner/s share responsibility of your business. Your partner can be a person, another partnership, or even a limited company.

You’ll need to decide which one of you is the ‘nominated partner.’ This will be the person who’s responsible for the partnership’s legal obligations, such as bookkeeping and tax returns – so choose wisely!

Once you nominate a partner, they’ll need to register the partnership for Self Assessment as an entity in its own right. Individual partners are responsible for registering themselves.

 

If you’re starting a brand-new business venture with one or more partners, you’re most likely looking for flexibility and simplicity. A limited company may be a little complex with lots of record-keeping, while partnerships offer the same type of autonomy as a sole trader, but in this case, liabilities are shared. As they say, two heads (or maybe more in this case) are better than one!

 

What are the pros and cons of setting up a business partnership?

Pros Cons

Easier to get started, with fewer legal obligations.

More capital if there’s more than one partner in the business that can invest and fuel growth.

Unlike a limited company, company documents will not be shared online for anyone to access. You can’t put a price on privacy!

No independent legal status outside of the partners of the business. Unless there’s a partnership agreement put in place (which is ideal), the partnership will be dissolved upon the death or resignation of one of the partners.

Unlimited liability, which means each partner is liable for any debts and losses incurred within the business.

The partnership itself doesn’t pay tax, even though it submits a tax return. Instead, each partner pays tax on their share of the profits. This might mean that a partnership is less tax efficient than a limited company, where you can draw out dividends.

 

Bottom line:

A business partnership is great for two partners or more to share ideas and grow a company in a flexible way. You may find though, like with sole traders, it’s difficult to get investors, and once you earn over a certain threshold it’s less tax efficient.

Starting up as a limited liability partnership (LLP)

A limited liability partnership (LLP) limits the extent to which partners are ‘liable’ for any debt that is incurred within their business. This differs from sole traders and individual partners in partnerships, who are personally liable for any business debts.

There is some liability though, although it’s ‘limited’ to the amount they’ve invested.

Like a partnership, all members manage their own Self Assessment, but they must appoint a minimum of two partners to become ‘designated members’. The designated members are responsible for filing account information and tax, much like the ‘nominated partner’ in a partnership.

This may be a great option if you want to start a business with other partners, while remaining liable for your own investments within the business, rather than the business as a whole.

 

For example, if you and three partners open a law firm (which is considered a high-risk industry) and something goes wrong (such as a claim towards the business), instead of having full liability, you’ll only remain liable for your own investments.

 

 

What are the pros and cons of setting up a limited liability partnership?

Pros Cons

An LLP is its own separate entity, which means members are only liable for what they’ve put into the business.

As an LLP, your business may be more attractive to potential clients than it would as a sole trader or partnership.

It gives you and your partners the flexibility to decide how profits will be divided between you.

Because an LLP is registered with Companies House, you’ll need to submit accounts and include what each partner earns. Some of this is public information, leaving your LLP with less privacy.

If there are only two members of an LLP and one leaves, the partnership will be dissolved and removed from Companies House.

Fewer tax benefits than the likes of a limited company.

 

Bottom line:

An LLP is a great option for reducing liability and is used amongst high-risk industries such as accounting, construction, and law. It does make your business finances more publicly visible though, and if you only have two members, there can be implications if one wants to leave.

 
Whichever business structure you choose, you need good bookkeeping! Check out Pandle and sign up for your free account today.


Rachael Johnston

A creative content writer specialising across business, finance and software topics. I have a love for all things writing, and creating engaging, easy to understand content that helps everyday people!


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