Sole trader, partnership, limited company or LLP? Lets figure out what is the right legal structure for your startup. You’re ready to start your business. How to choose the right legal structure for your startup? There are options – sole trader, partnership, limited company, or LLP.
One of the first decisions is company structure. To help you decide we look at the advantages and disadvantages, and ongoing regulatory and tax filing associated with the four main startup structures. If you’re not planning to raise significant funds on the stock exchange in your business plan, it probably won’t be helpful to start off as a public limited company (PLC), so the other choices are : become a sole trader, form a partnership, incorporate a limited liability company, or partnership (LLP) at Companies House.
There are other structures, including community interest companies and co-operatives, offshore companies, and franchises. But here we will focus on the most common choices. Once you have looked at the options, its a good principle to start with the simplest structure to fit your business plan. You can change to a more complicated model as the business scales up.
What are the advantages of registering as a sole trader?
It can be better to be a sole trader if you’re not going to employ anybody. The reasons are:
- There are no dues or fees to pay to register
- You can immediately go out and order your business cards
- Most new businesses are set up as sole traders – its easy
- Its inexpensive to begin trading
- There’s not much red tape when you startup
A sole trading business can employ staff, most are one man or one woman businesses, and most operate in service sectors like business related services, marketing, hairdressing, and building.
As a sole trader you can make instant decisions which is better than the frustration, convincing, and waiting on agreement from colleagues or board members. You can now give up the waiting, and stop giving your competitors the chance to grab a marketing advantage while you wait for others.
The best part is everything you earn belongs to you alone net of tax. The disadvantages of registering as a sole trader
At law, for a sole trader, law makes no distinction between the business and its owner. That is, business liability is unlimited for the sole trader. Any business debt can be met from the owner’s personal assets if the business fails.
And, the sole trader business won’t usually continue as a going concern on retirement or death of owner. As a sole trader, profits are taxed as income by HMRC. As you’re self-employed, tax is self-assessed. This means you should be no worse off than if you were an employee.
As you start you will appreciate it that many expenses such as costs of your place of work, and business travel, even if you work from home, are tax-deductible. You will be required to register for self-assessment with HMRC, file an annual tax return, and there the paperwork basically ends.
It’s not until the business grows that the problems of sole trader become apparent. Because your profits are taxed as income you will be paying 40% tax as soon as income tops £43,300, and 45% tax over £150,000. Tax for sole traders is a risk, and a greater risk of personal liability.
When and why should you register as a sole trader?
When you choose a low cost startup, you’re may not need to borrow funds to grow the business. Thus your financial risk may seem only debtor risk. But you can incur liability for other liabilities like professional negligence. Any bills in the name of the business are your personal liability.
Being a sole trader can be an exposed position. The independence of being your own boss can make it a lonely job when you carry the burden alone. You are liable for debts and future liabilities. If someone sues the business, you carry the legal costs and debt, and can go bankrupt. Just as with personal debt you can lose your personal assets to meet debt. Its an exposed position.
Forming a Partnership
A partnership for a startup can work if you’re offering services with people known to you. Many professional, virtual, and handyman/woman services, startup as sole traders or partnerships. But beware its advisable to consider incorporating a company if you sub-contract work from larger companies.
Its a natural progression for sole traders to graduate to partnerships. For example when two partners in marriage or well known friends work together to build a business. Sharing the running of the business is necessary when one person is sick or needs a break.
In planning this kind of startup structure there needs to be a partnership agreement setting out how liabilities,ownership, and profits are to be split. The partnership agreement also needs to address how one partner might be able to quit, have their partnership valued, and how to close the partnership, for example, if it doesn’t work out between the partners. The only legal requirement with a partnership, as with a single person business, is each partner is HMRC registered as self-employed and files separate tax returns.
Standard partnerships, like sole traders, agree all partners are responsible for all debts of the business. Its important to be careful about the conduct of potential partners because once a legal partnership is established you are responsible for not only the debts you incur, but those that other partners incur.
A partnership like this is ‘unlimited’ and very different from the structure and liabilities of limited liability partnership (LLP), which we look at next. But in both partnership structures your profit will be taxed as income.
As well, if your profits are over £5,965 you will, in addition to personal taxes, have to pay Class 2 National Insurance contributions (NIC) at a rate of £2.80 per week;
If your profits are £8,060 per year you will have to pay Class 4 9% NIC taxes on profits up to £43,000. Profits in excess of £43,000 you will have to pay 2% NIC tax on profits. (https://www.gov.uk/self-employed-national-insurance-rates)
Calculate whether you do better as a sole trader or limited company with the simple calculator from Companies MadeSimple.
Incorporating a limited liability company (LLC)
A limited liability company or LLP needs to be incorporated and registered at Companies House. Setting up formally like this gives credibility to your startup. Incorporation can also help to borrow money when the company needs a loan. But be truthful with yourself about why you want incorporation. If you like the idea of being a Managing Director of a limited company for the status, remember it carries the time consuming responsibility of preparing year end accounts.
Once the business is registered at Companies House as a private limited company there are constant administration tasks required. You may need to pay for professional help which can be an extra expense. You can file documents online. You can be sole shareholder and director, and act as company secretary as well (appointing a company secretary is no longer a legal requirement)/
Private limited companies are owned by shareholders. Liability is limited by the amount of the shares. This means that the maximum a shareholder could be required to pay for any company liabilities, debts, or legal claims, is the face value of the shares held.
The distinct advantage of limited liability is to control your exposure to financial risk. There is a legal boundary between your personal assets and the company. It works this way because at law the limited company is a separate legal entity to the company shareholder. Therefore the business entity shoulders the financial liability if the business collapses. And your home, your family, and your personal lifestyle is protected. Unless you ever sign a personal guarantee for business loans in excess of shareholder holding.
In addition, the tax structure for registered companies is more favourable than for a sole trader. Taxes are paid on profits of limited companies, plus the directors are taxed as employees in the same way as any employee of any company is taxed. The UK small profits corporation tax rate, applied up to £300,000, is now 20%, and will drop to 17% in year 2020. In a limited company the company taxes due are separate from the personal taxes you pay on your salary from the business.
As a trading company, you are expected to annually submit to HMRC full statutory accounts, and a company tax return, as well as making monthly or quarterly payments of employee income tax (PAYE), NICs you deduct, plus VAT filings and tax payments.
You will also have to file statutory accounts and Annual Returns to Companies House. Small and medium-sized companies (with turnover less than £5.6m) can submit an abbreviated version. Review this handy checklist to help you complete all the accounts and filings required on time.
Before you start trading you need to formally register the limited company, appoint the company officers, and choose a name for your business. Once the company is registered you are ready to start. If starting a limited liability company sounds right for you, read our step-by-step guide to setting up a limited company.
Incorporating a limited liability partnership (LLP)
LLPs structures are especially suited to professional services companies. They are seen as a hybrid between limited liability companies and traditional partnerships. They offer limitations to partner liability, like shareholders of limited companies. They also offer a more advantageous tax regime, and the flexibility available to non-LLP partnerships. In an LLP, partner numbers are not limited, but two must be ‘designated members’ responsible for filing annual accounts.
Just like a limited company a limited liability partnership protects members’ personal assets, limiting their personal liability to the business liabilities. This liability limitation applies regardless of how much someone invests in the business and can include limited liability on personal business guarantees on business loans, as long as its stated in the guarantee document.
But an LLP doesn’t give the same tax advantage as LLC.
An LLP, like ordinary partnerships, is taxed on profits as income. Each LLP member has to register with HMRC as self-employed. LLPs have to register at Companies House. There must be a members agreement stating share of profits and other agreements between each member.
If your start-up is in the financial or legal sector, and you hope to attract other professionals as you build more business, it may be worth considering an LLP from the beginning. The LLP is often adopted by some of the largest UK accountancy and legal practices for example. Its an appropriate vehicle for business growth for certain start-ups.
How to register your company
We’ve chosen to partner with Company Formation MadeSimple, an approved e-filing partner of Companies House (for the last 7 years). The only company formation agent in partnership with ICAEW (Institute of Chartered Accountants in England and Wales). Company Formation MadeSimple have registered over 500,000 UK limited companies, partner with complementary service providers like Barclays and Vodaphone, and offer a number of online formation services for first-time and serial entrepreneurs startup partnerships and company structures alike.