As you embark on setting up a business, there will undoubtedly be many questions, specifically, which business model is right for you. The way in which you set up your business can have implications for tax, how decisions are made, ownership of the business and also, the level of administration that is required. It is therefore important to select the right business model that shall suit your business plan. There shall be four types of models assessed in this blog: Sole Traders, Partnerships, Limited Company and Limited Liability Partnership.
A Sole Trader is someone that operates a business on their own and as an employed person. The individual shall have the right to make all the decisions impacting the business and the individual shall own all assets of the business. However, as the individual and business are treated as the same entity, the individual is responsible for paying income tax on all the profits of the business and has unlimited liability for the debts of the business.
However, there are various benefits to being a Sole Trader. Firstly, the individual shall not need to register the business with HMRC, but, would simply need to inform HMRC that they are operating and are self-employed for tax purposes. Secondly, there are far less administrative matters to deal with as a sole trader and there are far less complications when desiring to take money out of the business, as all profits belong to the owner. Lastly, there is no need to file annual accounts or submit a confirmation statement.
However, like all business models, there are shortfalls to being a Sole Trader. As there is unlimited liability for business debts, the owner has sole liability to pay the debts. In addition, a Sole Trader lacks status of incorporated forms and most importantly, there is no day-to-day support.
Entering a Partnership
A Partnership is governed principally by the Partnership Act 1890, it occurs where two or more persons run and own a business together with a view to make a profit. A Partnership is unincorporated and is not a body corporate. A Partnership Agreement will be the legal doctrine that governs the Partnership and will be the document that decides how the partnership is run. Terms within a Partnership Agreement can be expressed or implied, the Partnership Act 1890 will imply terms into a partnership in the absence of express/implied agreement. Certain provisions of the Partnership Act 1890 cannot be varied, for example, Partner’s liability and illegal Partnership. Certain provisions that may be expressly included in the Partnership Agreement are retirement, governing the question of when a partner can retire and of payment for their share by the other remaining partners and in addition, the role of all Partners in the Partnership.
A Partnership is very easy to form and only requires two people. An advantage of forming a Partnership is that the owners have freedom to run the Partnership as they view fit. Contrary to Sole Traders, a Partnership brings collective decision making, which in turn leads to shared profits between all Partners.
Similarly, to Sole Traders, there is unlimited liability for the firm’s debts. Further, decision making can be quite cumbersome, and a lack of written expressed agreements may lead to uncertainty. A Partnership lacks the status of incorporated forms and a leaving Partner must be bought out by the remaining Partners, which may not favourable.
Whilst a Partnership can bring many advantages, similarly to Sole Traders, the Partners and the business are treated as the same entity and therefore, Partners will be personally liable to pay any debts that have been incurred by the business. However, Partnerships are straightforward to set up and are more flexible than limited companies in structure.
A Company in the United Kingdom is formed by registered certain documents with a public official, in accordance with the Companies act 2006. As opposed to the aforementioned two business models, a company is a separate legal entity and any debts incurred by the Company are the Companies debts. Decisions are made either by the Company’s directors or shareholders. Directors run the company on a day-to-day business and make decisions that shall impact the company and shareholders are the owners of the business that will make the major decisions impacting the company. The Company is not subject to income tax, but corporation tax. Liability is limited to the company’s constitution- Companies Act 2006; this can be limited by shares (which is more usual) or by guarantee.
A company form brings significant benefits, for directors and shareholders, there is limited liability for business debts. Furthermore, there is a greater status than other business models considered and lastly, there is potentially a larger pool of investors.
However, the process of setting up a Company is much more considered than the previous two models discussed. As noted, the Company must be incorporated with Companies House and the Articles of Association for the Company must be filed with this. As well as this, there are extra-legal duties and potential liability for directors, if the director’s duties are not complied with, such as acting in the best interests of the company. As a Company, information must be made public, including the finances of the company and in addition, information of the directors and shareholders.
Limited Liability Partnership
A form of unincorporated business is established under the Limited Partnerships Act 1907. It is similar to a Partnership in that there must be at least one general Partner who has unlimited liability for the debts of the Partnership. However, a Limited Liability Partnership (LLP) is permitted to have a limited Partner whose liability is limited to the amount that they initially invested, providing that the individual is not controlling or managing the LLP, not having the power to make binding decisions and not removing their contribution to the LLP for as long as they remain in the business. Unlike ordinary Partnerships, LLP’s must be registered with the Registrar of Companies.
LLP’s bring many benefits, but most importantly, there is limited liability for business debts for the Partner’s. Similarly, to ordinary Partnerships, the Partners have the freedom to run the Partnership as they view fit and have the support of joint decision-making.
To form a LLP, the Partnership must be registered and information, including your finances, must be made public. As expected, there are additional formalities and costs to run the Partnership.