Setting up a Business in the UK - which business structure is best for you?
What business structure?
So you have had that one great idea which you are going to turn into a business, you’ve done your research and you are almost ready to go. At this point you need to decide what business structure to use to start off with. You can always change later, but it is best to get it right first time if you can. The choice of business structure comes down to two main options: limited company or unincorporated business. So which should you choose?
Sole Trader (unincorporated business)
We’ll start with the unincorporated business. If you are setting up your own you will be a sole trader, or if you have business partners who will be sharing in the profits of the business (i.e. not merely employees) the business will be a partnership. Sole traders and partnerships work in broadly the same way, the only significant difference being that profits are split in a pre-arranged ratio (this will be set out in a partnership agreement). For simplicity in explaining , when I refer to a sole trader I am meaning both sole trader and partnership.
Perhaps the biggest advantages of setting up as a sole trader are simplicity and low cost. There are no statutory accounts or annual return, no meeting minutes, resolutions or share paperwork required. From an accounting perspective, the only legal requirements are tax related. You will need to prepare an annual personal tax return (which you may do already depending on what other income you have) and for this you will need some sort of profit and loss or income and expenditure account to calculate your business profits for the year. If you employ people you will need to do PAYE forms too, and you depending on what you do and your level of sales you may need to do VAT returns but you would have to do these forms as a limited company anyway. If you asked an accountant to prepare your tax return and any other required forms, it would be significantly cheaper than if you were a limited company (probably half the price or less).
In Limited Company
As we’ve already seen, limited companies have much more paperwork, which invariably costs a lot more (and while tackling your income tax return yourself is a possibility, you couldn’t do all the paperwork and accounts yourself if you were a limited company). Another disadvantage which isn’t at first obvious, is that any profits and cash generated in the company is not yours to spend, not immediately anyway. You have to extract profits from the company by way of a salary (for which you will pay income tax and national insurance, and require more forms) or as a dividend (though there would have to be sufficient ‘retained profits’ in the company to do this, and it would again require more paperwork). This can be difficult for some people to manage.
So what are the advantages of a limited company? Well, one of the main advantages is in the name. Companies have limited liability. Except in rare cases (usually involving fraud or gross negligence), the company owners (shareholders) can’t be liable for any debts over and above what they have put into the company. As a sole trader, if your debts overtake you, your creditors could come after your personal possessions, house etc.
Tax is potentially another big advantage of operating through a limited company. There may be more forms, but often if set up correctly you can pay a lot less in tax and national insurance than if you were a sole trader. This depends a number of factors, including what level of profits you are making and whether you are spending all of the money you make each year.
Finally, operating as a limited company can be very useful as your business grows, in allowing you to reward valued employees with shares or share options, or to encourage outsiders to invest in your company to raise extra funding.
So to conclude
The choice of which business structure is up to you and will depend on your circumstances. Hopefully this article will have provided a good general outline, however it is not any substitute for obtaining professional advice from accountants and/or solicitors.