Company Formation Services
How Doing Business in UK
Choosing the Best Ownership Structure
For Your Business
1. Sole Trader (Self-Employed)
You should think carefully about which structure suits your particular circumstances before making a decision. Choosing the wrong structure could expose you to unnecessary costs and risks, while failure to address certain practical issues may result in you falling out with your business partners or associates. Having said that, the status of sole trader suits many professions where starting up does not require major investment, and where a skill – such as carpentry, bricklaying or freelance services – is just as important as business acumen. It will not stop you from employing people when you start to get busy, but it will allow you to keep a tight grip on your business and to run it as you wish.
Today, there are several business entity options available for entrepreneurs. Like anything else, each of them has advantages and drawbacks:
You could set up in business with a colleague or friend. Perhaps you each have different skills to bring to the enterprise. One may be a good sales person and negotiator while another has the ability to provide a service, like mending guitars, writing websites, compiling accounts, analysing markets or sculpting. When you go into business with someone else, this is usually known as a ‘partnership’. Everyone might own an equal share or some may have a larger proportion of the business than others. In a partnership, you are liable for the debts of the business in proportion to how much of it is yours and your income may be of a similar proportion.
Unlike other business formats, partnerships (and sole traders) can start trading straight away, although certain types of businesses may need a licence to trade. If trading under a name other than that of the owners, must display names of owners and an address, for each, at which documents can be served. Behind sole-traders, a partnership is the second most popular type of business and is more commonly associated with professional services such as accountants, solicitors and doctors. It is also common in partnerships for each partner to specialise in a specific area of the business. For example, in an accountancy service, one partner may specialise in bookkeeping, another partner may specialise in financial advice, and so on…
You have to be aware that because any decisions and actions are dependent on the other partners agreeing, certain conflicts may arise from time to time. Such conflicts have led to partnerships failing and so it is important that some control can be maintained by compiling a ‘partnership agreement’ prior to starting the business. This agreement will be outlined later in the article.
Types of Partnerships
(A) The General Partnership
The General Partnership, which is the scenario outlined above and is subject to The Partnership Act, 1890. Full partnerships, as outlined above, have between two and twenty partners, but more commonly, the number of partners in a full partnership lies between two and four inclusive.
An arrangement in which two or more individuals or other persons (such as a company and an individual) conduct business as partners, whether officially or not.
In terms of asset protection, general partnerships can be even worse than sole proprietorships. Anything that one partner does affects all of the partners, because each partner of the general partnership is personally responsible for all obligations of the partnership deals. Thus, each general partner’s exposure to risk is increased by a factor equal to the number of general partners in the business.
(B) The Limited Partnership
The Limited Partnership, which is subject to The Limited Partnership Act, 1907. Limited partnerships they are very rare today and account for less than 1% of all partnerships in the UK. A limited partnership is formed when one or more of the partners invest capital into the business but do not participate in running and managing the business. These partners therefore have limited liability as they can only lose the amount of money that they initially invested into the business.
A Limited Partnership (LP) is an association of one or more general partners together with one or more limited partners to conduct business for profit as co-owners. The most important feature of a LP is that the limited partner enjoys limited liability as long as s/he does not participate in the control of the partnership business. The general partners of the LP are the ones who are responsible for the obligations of the LP.
In a limited partnership, it is the general partner who remains liable for the debts and obligations of the entity. For larger risk exposure, a company (corporation) may be formed to serve as the general partner. A corporate general partner is protected from direct attack by a judgment creditor because the ultimate liability for the debts and obligations rests with the shareholders. By spreading share ownership, individual exposure is considerably reduced. Even without a corporate general partner, risk can be spread by distribution of limited partnership shares. If a judgment creditor obtains a charging order against one partner, the order goes to that partner’s share in distributions from the partnership, and not to the entire business.
(C) The Limited Liability Partnership (LLP)
An LLP is similar in some ways to a standard Partnership, except that the individual members have lower liabilities to any debts which may arise from running the business. There are more administrative duties involved compared to the Partnership business structure. In fact, an LLP is more similar to operating a Limited Company. In terms of liability, the Limited Liability Partnership is itself liable for debts run up in running the business, rather that the individual members of the LLP. As a result, LLP’s are only recommended for profit running businesses.
An LLP may be formed by two or more persons (individuals or companies, and not necessarily UK resident) to carry-on a trade or business. To form an LLP, the partners have to file an incorporation document at Companies House. The owners and managers of an LLP are the same. The management structure and relationship between the partners are a matter for agreement between them and may be recorded in a separate LLP Agreement, similar to a Partnership Agreement.
No personal liability on a member for the LLP’s debts and contracts
No joint and several liability for the negligence of any member
As a separate legal entity, LLP’s may own property, sue, and be sued in LLP’s name
Members’ liability to contribute in a winding-up is limited to the amount they agree to contribute in the event of a winding-up as recorded in the LLP agreement.
Disclosure: information (in particular accounts and an auditors’ report) must be filed with the Registrar of Companies and becomes public
Money and property contributed to the LLP becomes owned by the partnership unless otherwise stated and the contributor is not entitled to its return except as stated in the partnership agreements
Regulation: auditing and filing requirements.
3. Limited Companies
A third way to run a business is as a limited company. The business is registered with Companies House and is an entity of its own. There are more rules associated with running a business this way but there may be tax advantages. Those involved have shares in the business proportional to their involvement. A limited company is regarded in law as a separate legal personality, distinct from its shareholders. For this reason, if the company for any reason is unable to meet its liabilities, the shareholders will only be personally liable for the unpaid amount of their shares. If the shares are fully paid, then the shareholder cannot be asked to pay anything further.
It is therefore, strictly speaking, incorrect to say that a company has limited liability; it is the shareholders whose liability is limited – up to the unpaid amount of their shares. This situation must be contrasted with the personal liability of a sole trader or a partner in a partnership (with the exception of a partner with limited liability or in the case of a Limited Liability Partnership (LLP)). In these cases the sole trader or partner may be personally liable for any debts which the business is unable to meet. As noted above, there may be instances when personal liability cannot be limited. This situation usually affects directors who may be personally liable if they have acted fraudulently of negligently. In particular, you should be aware of the personal liability which can accrue to directors if their company trades whilst it is insolvent.
Whilst the limitation of liability can prove attractive, you should be aware that in certain cases, notably when dealing with banks or other financial organisations, personal guarantees may be requested from the directors, and/or shareholders. This may then negate this particular advantage.
The UK draws a distinction between employment income and self-employment income. Directors are taxed on the basis that they have employment income. But in some countries the dividing line would be drawn at a different point and directors who are not full-time officers may be treated as independent contractors (that is, as if they were self-employed). All businesses have to comply with certain legal requirements. This can include requirements in relation to health and safety, Trade Descriptions Act, Data Protection Act and Employment Law, to name but a few.
As well as being a legal requirement, good health and safety practices pay for themselves by improving your reputation with customers, the local community and most importantly your own employees. If you employ five or more people, you are required to prepare a statement of policy on health and safety at work and to make arrangements to put this policy into practice.
Limited Company VS Partnership
Advantages and Disadvantages
Should you operate as a limited company or partnership? Or perhaps go for limited liability partnership (LLP) status, which some believe offers the best of both worlds? It is essential to select the appropriate status for your business, as this will determine a number of other issues including tax, future succession of the business and many other factors.
Whilst it is frequently assumed that incorporation brings substantial tax benefits and greater financial protection to directors, this is not always the case. In fact, for some businesses, running as a partnership can be the most efficient and rewarding route.
Each firm must assess its particular ambitions in view of current circumstances and decide the most appropriate route. Indeed, selecting the best operating vehicle for your organisation is just one part of business planning, but first, let’s recap on some basic differences between limited companies and partnerships.
A limited company is a legal entity, run by directors and owned by shareholders, who are frequently the same people. Each company must publish its annual accounts, although small organisations need only provide a basic financial summary and for those with turnover under £5.6 million per annum, no audit is required.
In contrast, partnerships are owned and run by individual partners who are personally and jointly responsible for the actions of their fellow partners which partly accounts for the importance of a partnership agreement or deed.
Partnerships do not have to publish or audit their accounts, however large they get, although there is a move towards increased transparency.
A few of our clients have set up a limited liability company to run alongside the partnership to which different types of projects are directed. This affords maximum flexibility and helps the business to protect itself. It can also be a useful means to ensure succession as partners leaving a partnership can result in dissolution whereas a company continues, even when directors retire or leave.
Limited liability partnership, which became available from 6 April 2001, brings the benefits of limited liability whilst maintaining a traditional partnership. Not surprisingly, an increasing number of businesses of all sizes are considering this.
As the members have limited liability, the protection of those dealing with an LLP requires that the LLP maintains accounting records, prepares and delivers audited annual accounts to the registrar of companies, and submits an annual return in a similar manner to companies. The exemptions (and limits) available to companies with respect to delivering abbreviated accounts and exemption from audit also apply to LLP’s.