How to Choose the Best Legal Structure for Your Business

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Deciding to start your own business is an exciting decision but it can also leave you feeling a bit unsure as to what type of business structure will be best for your new venture. It is an important decision to make because each business type has certain legal rules and requirements that are not so easy to change once you have made up your mind.

In the UK there are four main types of business types that you could choose to register your business as each with its own distinct characteristics. It is up to you to decide which one will suit your business model best. The four main types of business structures in the UK are:

  • A sole proprietorship is the most popular business type in the UK presently and is one of the simplest business types to start on your own. A sole proprietorship has many advantages for an entrepreneur wanting to start their own business as the sole owner of the company. A few of the benefits that come with starting a sole proprietorship include:

-   No profit sharing with anyone else.

-   There are lower costs involved to start up your business than other business   types as you are not obligated to register your sole proprietorship at the Companies House but you are required to advise Her Majesty’s Revenue and Customs.

-   An easy-to-change business structure that you can change as your business grows.

Disadvantages include:

-  One of the main disadvantages of a sole proprietorship is that you have unlimited liability (i.e. the business has no separate legal identity from the business owner) meaning your personal assets can be seized if the business is unable to pay its liabilities such as its creditors for example.

-  From a tax perspective, although the tax payment structure is relatively simple compared to other business types, it can also amount to more as you are taxed on your personal income/ profits of the business which increase as your profits increase.

-  Difficulty to secure additional funding from traditional financial institutions if you don't have the requisite assets to use as collateral (which a lot of small businesses don't have, especially in the startup phase).

  • A partnership usually has between two and four partners in the partnership but this number can go up to twenty and can be classified into two groups - an unincorporated entity and a limited liability partnership.

An unincorporated partnership will share all the profits and losses according to a ratio that is agreed upon and each party will then pay their tax based on their individual profits. The business is also run by both parties who jointly take on the responsibilities of running the business. Advantages of a partnership include:

-   It  offers flexibility in terms of the dissolution of the partnership should one partner choose to leave the partnership.

-   Like the sole proprietorship, it is also relatively straightforward to get started and also doesn’t need to be registered with the Companies House but only with the HMRC for taxation purposes.

-   It offer the opportunity to leverage each partner’s strengths for the benefit of the business.

Disadvantages include:

One of the major disadvantages of starting a partnership is that the partnership has unlimited liability, and:

  • Each partner is liable for the negligence of their partner/s.
  • The potential for conflict and disagreements increases should there be a dispute/ difference of opinion between partners.
  • There is also the option of a Limited Liability Partnership or LLP. The key difference between an LLP and an unincorporated identity is the extent of their liability. The partners of an LLP have limited liability which means that their liability is limited to the funds invested in the business only where the opposite is true for an unincorporated entity. Other tax requirements that apply to an LLC include submitting a Self Assessment Tax Return each year as well as National Insurance payments to Her Majesty's Revenue and Customs or HMRC.
  • A Limited Company - is a separate legal entity with its own rights and responsibilities. The structure of a limited company consists of a director/s who run the company and the shareholders who own a stake in the company.

The tax paid by a limited company is known as Corporation Tax and this is deducted first from the company before any profits can be distributed to its shareholders in the form of dividends.

 The liability of a company's shareholders can be limited by the price of their shares in a company or it can be limited by guarantee for private companies that don't have shareholders but instead have guarantors who take on the responsibility of settling any outstanding debts.

Deciding on which legal structure to choose from can seem a tall order but having an in-depth knowledge of the legalities of how each company structure works will hopefully help to make your decision a bit easier. Looking at starting your own business but need advice on how to start? Click here