One of the first decisions any new business owner faces is how to structure their business. It is a decision that affects everything from how much tax you pay, to your personal liability if things go wrong, to how easy it is to bring in investors or partners in the future.
There is no single right answer – the best structure depends on your circumstances, your plans for the business and your attitude to risk. Here we explain the three main options and the key considerations for each.
Sole trader
Operating as a sole trader is the simplest way to run a business. You are self-employed, you keep all the profits after tax, and there is very little administrative burden – you register with HMRC, complete a self-assessment tax return each year and keep basic financial records.
The main drawback is unlimited personal liability. As a sole trader there is no legal distinction between you and your business, which means that if the business runs into debt or faces a claim, your personal assets – including your home – could be at risk.
A sole trader structure works well for individuals starting out, testing a business idea, or running a low-risk business with limited financial exposure.
Key features:
- Simple and inexpensive to set up
- All profits taxed as personal income via self-assessment
- Unlimited personal liability
- No requirement to file public accounts
Partnership
A partnership is broadly similar to a sole trader arrangement but involves two or more people running a business together. Each partner shares in the profits and, unless a formal partnership agreement says otherwise, each is jointly and severally liable for the debts and obligations of the business – meaning one partner can be held personally liable for the actions of another.
For this reason, a properly drafted partnership agreement is essential. Without one, the default rules under the Partnership Act 1890 apply, which may not reflect what the partners have actually agreed between themselves.
A limited liability partnership (LLP) is a separate legal structure that offers partners protection similar to that of a limited company, while retaining some of the flexibility of a traditional partnership. LLPs are a popular choice for professional services firms.
Key features:
- Straightforward to set up but a formal agreement is strongly recommended
- Each partner pays income tax on their share of profits
- Unlimited personal liability in a traditional partnership
- LLPs offer limited liability protection
Limited company
A limited company is a separate legal entity from its owners. It can enter contracts, own assets and incur debts in its own name. The liability of the shareholders is limited to the amount they have invested – so if the company fails, their personal assets are generally protected.
In return for this protection, a limited company carries more administrative obligations. You must register with Companies House, file annual accounts and a confirmation statement, and comply with company law requirements. The company pays corporation tax on its profits, and directors and shareholders pay income tax on any salary or dividends they draw.
A limited company structure is generally more tax efficient once profits reach a certain level, and it can make the business more attractive to investors and lenders. It also gives the business a more permanent, professional identity that is independent of any individual.
Key features:
- Separate legal entity with limited liability for shareholders
- More administrative requirements and filing obligations
- Corporation tax on profits; income tax on salary and dividends
- Greater credibility with lenders, customers and investors
Which structure is right for you?
There is no universally correct answer, but some general principles apply.
If you are just starting out with a low-risk business and want to keep things simple, operating as a sole trader may be the most practical option initially. You can always change your structure later as the business grows.
If you are going into business with one or more partners, putting a formal partnership agreement in place from the outset is essential – regardless of how well you know each other. Disputes between partners are one of the most common causes of business failure, and a well-drafted agreement can prevent many of them.
If your business carries significant financial risk, you are planning to grow quickly, or you want to take on investment, incorporating as a limited company is likely to be the better choice. The additional administrative burden is manageable and the protection it offers can be significant.
Getting the structure right from the start
Changing your business structure later is possible but can involve cost and complexity – particularly if there are assets, contracts or employees to transfer. Taking legal advice before you start, or at an early stage, can save considerable time and expense down the line.
A solicitor can also help you put in place the foundational documents your business needs – whether that is a partnership agreement, shareholders’ agreement, or articles of association – to protect your interests and set out clearly how the business will be run.
Speak to Oxford business law solicitors
At Challenor Gardiner we advise new and established businesses across Oxford and Oxfordshire on business structure, commercial agreements and a wide range of other business law matters. We offer practical, straightforward advice without unnecessary jargon.
Call us on 01865 721451, email info@challenor-gardiner.co.uk or contact us online.