When starting your own business, you need to decide which business structure to follow. There are four key types of company formation – sole trader, partnership, limited liability partnership and limited company.
Understanding the difference between these, and knowing which one should to use can be confusing…
As a sole trader, you run your own business as an individual and are self-employed. You and your business are effectively the same thing, from both a tax and legal perspective.
You can keep any profits your business makes after tax with all income declared on your annual self-assessment tax return and classed as your personal income that year.
You don’t need to register your business but should tell HMRC that you are self-employed for tax purposes.
The Sole Trader structure is ideal for many small business owners, especially freelancers with only a few clients and/or an annual income below £20,000.
Pros of being a Sole Trader:
- All profits are yours
- Easy to set up
- Low startup costs
- Fewer financial restrictions
- Business can be kept private
- In control of all business decisions
- Easy to close down
Cons of being a Sole Trader:
- Legally responsible for any losses or debts
- Harder to raise capital
- Hard to take time off when you work by yourself
A business partnership is when a company has multiple owners who are all invested in the business.
All partners will receive an agreed share of the profits and must each pay tax on their share. Any profits made by a business partner after tax is their own income.
Pros of a Partnership:
- Shared responsibility for any decisions
- Shared liability for any debts or losses
- Reduced financial burden
- Additional knowledge and manpower
Cons of a Partnership:
- You have to share the profits with other partners
- Potential conflict
- Less independence
Limited Liability Partnership (LLP)
A limited liability partnership (LLP) is similar to a business partnership in terms of tax liability and shares of the profits, but some or all of the business partners have limited liabilities.
LLPs tend to be used by professional services firms such as solicitors and architects.
Pros of an LLP:
- Each partner is taxed through self-assessment
- Internal structure is easy to change
- Personal assets are protected from the liabilities of the business
- Don’t need to hold a board meeting to make decisions
- You’re not liable for another partner’s misconduct or negligence
- Once registered your business name is protected
Cons of an LLP:
- Accounts must be made public
- An LLP must have at least 2 members – if one was to leave, the company may have to be dissolved
A Limited Company (LTD) is a completely separate legal entity, meaning it is separate from the people who own it. Any debt, losses or legal claims associated with the company are the responsibility of the company, not the owners
The business must be formed and registered at Companies House, with annual accounts filed and an annual corporation tax return submmitted. There will be certain legal documents that must be adhered to by LTDs.
Pros of a Limited Company:
- Receive income in the form of both a salary and dividends
- Business debts are separate from that of the owners
- Company name is protected
- More professional image
- Can raise additional capital by selling shares in the business to new investors
- Can split your business profits and minimise personal tax liabilities by issuing shares to family members
Cons of a Limited Company:
- More complex accounting and reporting requirements
- Accounts must be made public
- There are strict procedures for withdrawing money from the business
If you are still unsure which business structure is right for you, get in touch with Magpie Accountancy and we will be happy to help.