Should I be a limited liability company, a sole trader or a partner? These notes will provide you with some answers. If you would prefer to talk to a qualified business adviser please call us and we will help you reach a commercial decision on what is right for you.
When starting a new business it is important to establish the correct organisational structure for the enterprise. The choice can usually be made from the most popular types which are Sole Trader, Partnership or Limited Company. There are other models, e.g. Co-operative but they are less popular and so are not included in this brief.
It is useful to consider the main characteristics of these three types of organisation as this can lead to a conclusion about which is most suitable for your circumstances.
LIMITED LIABILITY COMPANY
What is it?
A company is a separate entity - a legal person in its own right, quite separate from those who own it (the shareholders) and those who run it (the directors).
As a separate person, a company can itself:
- own property
- employ people
- act as director or secretary of another company
- enter into contracts
- sue in the courts
- be sued
A private company may be limited by shares or by guarantee (a commitment to contribute a given sum if the company is wound up).
The key point to recognise is that a company has limited liability for its shareholders and the effect of this is that the members will not be required to contribute more than they have actually paid or agreed to pay towards settling its debts . This amount is usually determined by the value of the shares held, e.g. If a company has issued 100 ordinary shares of £1 each and they are fully paid, the shareholders will NOT have to pay any more.
Why have a Limited Liability Company?
This type of organisation is becoming more popular as evidenced by the number of companies being registered in the UK (currently in excess of 250,00 per annum). The reasons are not hard to find and are summarised as follows:
1)RISK AVOIDANCE by limiting liability - as outlined above and ESPECIALLY EMPLOYMENT LEGISLATION WEIGHTED IN FAVOUR OF EMPLOYEES. Risks that would normally be the responsibility of partners and sole traders become the responsibility of the company. Industrial tribunals are awarding up £50,000 to employees for compensation claims!
2) ANONYMITY - You can appoint nominee company officers and shareholders. No-one need ever know who is running the company!
3) Protection of name (Companies House will not register another name that is the same). Also if another name is registered and it is considered to be 'too like' another existing company the latter can lodge an objection with Companies House who can direct the new company to change its name. You may also want to consider UK Trademark protection of your company name, for further details on this service go to our trademarks page.
4) Many of the problems of partnership are avoided such as defining who is in charge, who owns the business (the shareholders), resignation of partner, etc.
5) More credibility in the market place.
6) Raising capital - easier to raise loans for the business, etc.
7) Tax Free Mileage. For business purposes the car mileage rate is 40p on the first 10,000 miles (£4000 per annum).
8) Reduced tax bills - Operating your business as a limited company is often more tax efficient.
Some disadvantages could be:
- Ownership of assets can be locked up in the company. However steps can be taken to mitigate this effect. e.g. directors owning property and leasing to the company.
- PAYE has to be operated.
- Details of the company's accounts, officers and shareholders must be recorded at Companies House. Although this removes privacy it does make the company much more transparent which will aid your clients in assessing the identity suitability of dealing with your company.
SOLE TRADER
As the name suggests this is suitable for an individual that wants to be a 'one man band' and completely responsible for every aspect of running the business. The major plus factor of being a sole trader is the freedom to make decisions on the way the business is conducted without reference to anyone else. And so it is possible to argue that a sole trader can seize opportunity the minute it appears without permission from partners or business colleagues and thus gain a market advantage. Also any assets built up in the business belong completely to the owner. This arrangement can suit the lifestyle and character of many people as it is also the least formal in respect of compliance with government requirement for paperwork to be completed. However, the downside is considerable and for a business proprietor it can be an undesirable or untenable position and at best ALWAYS leave them vulnerable. Therefore the following potential problem areas either by themselves or cumulatively could cause a shift away from being a sole trader:
1) Complete responsibility for all the debts of the business
2) Potential liabilities may increase the debts of the business, e.g. a successful claim for damages may increase the business debt and be a cause of bankruptcy. To loose property and other assets that took many years of hard work to accumulate can be heart-breaking for the individual and their family and with the law supporting the creation of the 'Blame and claim' culture this scenario is becoming more common. Especially vulnerable are those engaged in industries where public and workers can be at risk and able to sue if the letter of the law was not imposed in the workplace.
3) The accounts of a sole trader are confidential to the individual and therefore not a matter of record that can be publicly inspected. This will make it almost impossible to contract with public sector organisations who demand a degree of transparency in their business contracts with the private sector.
4) The tax regime is particularly unfriendly as tax will be charged all the way up to the current maximum of 40%. Many sole traders make the mistake of believing that they will only be taxed on the amount of drawings they make on the business. WRONG!!! Tax is charged on the amount of net profit left after deducting allowable expenses (NOT all expenses are tax deductible).
5) Are holidays or time off in emergencies an option? Can you afford to be away from work without causing loss or irreparable damage to the business. So do you need a partner or in the case of a company a co-director that will be as equally committed to the business as you.
PARTNERSHIP
This type of organisation works well when circumstances are suitable. It is the norm for firms such as accountants and solicitors where individuals need to preserve a degree of independence but also share the cost of facilities, e.g. offices, insurance cover, secretarial services, etc. Also many family run businesses benefit from this type of organisation so that working family members are partners and therefore co-owners of the business and its assets. It is also worth a mention that by registering under the Limited Partnership Act of 1907 it can provide protection for what are called Limited Partners. This Act distinguishes between Limited Partners who contribute capital but take NO active part in running the business and General Partners who may contribute capital and also work in, or manage the business. Limited partners are NOT liable for business debts beyond the amount of capital they have already contributed while General Partners are completely responsible for all debts of the business. The downside to being a partner is:
1) Generally all partners are 'jointly and severally' liable for the debts of the business. This means that if one or a group of partners incurred business liabilities that could not be paid then EVERY individual partner could be liable for the whole debt and it is entirely at the discretion of the creditor(s) against whom the action is taken. However, all is not doom and gloom as this problem has been mitigated by the Limited Liability Partnership Act of 2000. This Act requires the registration of the Partnership with Companies House and effectively limits the liability of each partner so that their personal assets are beyond the reach of business creditors.
2)All partners are assumed to have authority to act as agents of the partnership and their actions are binding on all the other partners.
3) A partnership deed will be required to guard against imposition of the less desirable terms of the Partnership Act 1890, e.g. if a partner wants to leave the business it must be wound up and the proceeds distributed amongst the partners. This would be undesirable if the business was perceived as a valuable ongoing concern. This website includes as one of its Free Downloads a checklist that should be considered when preparing a partnership deed.
4) Partners are all taxed on their proportion of the Partnership profits and like a sole trader could be paying a higher tax rate of 40% or 45%.
5) For family run business the passing of time can create enormous problems in succession planning as individuals attempt to leave their assets including partnership share to their heirs.
