When you decide to start a business – or, if you decide it’s time to grow your existing business and it’s in need of a change – you’ll need to choose the right legal structure. This has a big impact, as it changes how you pay tax, how much risk you’re taking with your money, how much work you have to do, and how easy it will be to grow, get investors or sell your business in the future. A lot of business owners make this choice too quickly or go with what seems to be the easiest route, without thinking about the long-term impact.
Why the Legal Structure of Your Business Matters
Legally, you have a different relationship with your business based on your legal structure. This is known as personal liability, and it determines whether or not you are personally responsible for business debts and legal claims. How your profits are taxed also changes depending on your business structure, and the amount of administration landing on your plate differs. You’re also likely to find that your legal structure has an impact on the way customers, suppliers and investors see your business. It’s easy to see how choosing the wrong legal structure for your business can put you at risk and cost you money.
Main Legal Structures for Businesses in the UK
Sole Trader
The sole trader structure is one of the easiest, and one of the most common, ways to run a business. When you’re a sole trader, you’re the only one who runs the business, and there’s no legal difference between you and the business. You keep all the profits, but you are also personally responsible for any losses.
Setting your business up as a sole trader is quick and easy, and you have complete control over business decisions. Plus, accounting is relatively straightforward. However, you’re personally liable for all debts and legal claims, which can be problematic if you run into any issues.
Partnership
A partnership is similar to a sole trader structure, but it has two or more people running the business together. Partners are responsible for the business – including its profits, losses and debts – and the partnership itself doesn’t have to pay tax. Instead, each partner pays National Insurance and tax on their share of the profits.
Partnerships are easy to set up, you can share skills and knowledge, and you’re able to change how profits are split. However, each partner is responsible for the business’ debts on their own, and partners can be held responsible for what the other person does. There’s a chance of disagreements if expectations aren’t clear, which is why a detailed partnership agreement is necessary.
Limited Liability Partnership (LLP)
An LLP is a good choice for people who want to start a business that’s somewhere between a regular partnership and a limited company. An LLP is its own legal entity – which means it can own things and sign contracts in its own name – and, like in a partnership, partners’ profits are taxed as personal income.
The limited liability that comes with an LLP keeps personal property safe, and the structure of the business can change as the partnership evolves. It’s also a good way to boost credibility in the workplace, as starting an LLP shows that you’re taking your business venture seriously. However, an LLP is more complicated to run than a regular partnership, and you’ll need to submit yearly accounts and confirmation statements.
Limited Company (Ltd)
One of the most common ways for UK businesses to grow is to become a private limited company. This is when the business is a separate legal entity from its owners – who are known as shareholders – and managers, known as directors. With a limited company, the business pays taxes on its profits, and directors have to pay personal tax on their salaries and dividends.
With a limited company, shareholders have limited liability, and it’s a structure that often becomes more tax-efficient as profits increase. It’s also a way to gain more trust from clients and investors, as limited companies are often seen as successful, legitimate businesses. You also benefit from there being a clear line between personal and business money. But, there are a few downsides. For example, setting up a limited company tends to mean more paperwork and admin for you, and directors have legal duties and obligations to keep on top of.
Things to Think About When Picking Your Business Structure
Risk and Responsibility
Limited liability can be very important if your business has contracts, employees, loans or possible legal claims. If you need limited liability to project yourself and your assets, being a sole trader or setting up a partnership won’t work.
Tax Efficiency
Sole traders and partnerships are easy to set up, but limited companies can save on tax, especially if you start making a lot of money. If you want to operate in a tax-efficient way, it might be worthwhile setting up a limited company.
Growth and Investment
If you’re hoping to grow your business and you’re going to be looking for investments, you might want to consider a limited company. Due to share ownership and clear compliance, investors often prefer to work with a limited company.
Administrative Responsibility
Some business structures require more administration than others, which means handling things yourself or hiring a professional. If you don’t want a lot of administrative responsibility, you might want to choose a simple, straightforward structure, like being a sole trader.
Plans for the Future
When you’re choosing the right legal structure for your business, think about the future. Don’t just think about where you want the business to be today, think about where you want it to be in three to five years time.
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When you decide to start a business – or, if you decide it’s time to grow your existing business and it’s in need of a change – you’ll need to choose the right legal structure. This has a big impact, as it changes how you pay tax, how much risk you’re taking with your money, how much work you have to do, and how easy it will be to grow, get investors or sell your business in the future. A lot of business owners make this choice too quickly or go with what seems to be the easiest route, without thinking about the long-term impact.
