If you’re just starting out in a new business, then it’s a good idea to understand about all the types of legal structures for businesses there are to choose from. The legal structure outlines what paperwork you will need to fill in, the taxes you’ll have to pay, how you can take a dividend from the business and, in the worst-case scenario, what happens if your business makes a loss.

Choosing a legal business structure

Understanding these legal structures allows you to choose the best one for your business so you know exactly what you can and can’t do, legally, where your business is concerned – here are many pitfalls. Legal structures will differ if you don’t live in the UK, so be sure to check with your own government’s website to get more information. However, don’t panic! Legal structures can be altered and adjusted to suit your specific circumstances.

Your own business will fall within one of the three main types of business structure:

Sole trader

Limited company

Business partnership

Sole trader

Registering as a sole trader is the most common legal structure new business owners opt for, mainly because it suits a low-cost start-up for self-employed individuals. If you start working for yourself, even before you’ve told HM revenue and customs, you will be classed as a sole trader. You run and own the business as an individual and personally retain all the profits after you’ve paid all running expenses and tax due. However, being a sole trader doesn’t mean you have to work alone, you can employ people. The “sole” part means you are the only person responsible for the business. A sole trader is a simple way to run a business; you send a tax return off each year, pay any income tax on any pre-tax net profit, pay Class 2 National Insurance on any profit up to £5,965 or Class 4 if it is over £8,060. If your turnover (not profit) exceeds £82,000 a year, it is mandatory for you to be VAT registered. A sole trader can be a great way to start off as your own boss, but it can be a risky path as you’ll be personally liable for pretty much everything, so assets such as your house, car, etc. will be at risk if your business goes badly.

Advantages

  • You can start immediately
  • It’s very easy and simple to start up
  • It’s the cheapest way to start
  • You keep all the profit
  • No fees incurred to register
  • Best of all, it’s just you! You make all the decisions and decide which way you want the business to go

Disadvantages

  • You are financially liable for everything
  • Your personal assets are vulnerable

There are no real hidden disadvantages, just obvious ones. If your business doesn’t go well, you don’t do so well either. Make sure you have confidence in your business and yourself. So if this type of business set-up relates to you, then check out our section “Setting up as a Sole Trader”.

Limited company

You can set up your business as a Limited Company so that it can be run as a separate legal entity. That means that, financially, it is self-contained or ring-fenced, so that your personal equity, home, car and everything in your personal life is protected. The majority of private limited companies are owned by shareholders and limited by share numbers.

There is a little more work involved in being a limited company. Before you start trading you have to register with Companies House and decide on the company officers and a name for your business. You will also need to file statutory accounts and an annual financial return each year as well as a tax return. Limited companies pay corporation tax on their profits and the directors are taxed on the salary the business pays them, the same way all other employees are paid and taxed. Limited companies are split into two main types – private and public. Private ones can be run by just one member but it cannot trade shares to the public. Public companies offer their shares to the public through an initial public offer (IPO). Being either private or public doesn’t change how big the company can become – there are some major private limited companies (PLCs), including Mars & Toys R Us.

Advantages

  • Less personal financial risk as a limited company is a separate financial entity.
  • It will make the business look more credible
  • Business loans may be more accessible
  • Likely to pay less tax than a sole trader
  • Your company name is protected
  • PLCs can sell stock to raise finance

Disadvantages

  • More paperwork is involved
  • Accounts need to be submitted each year
  • PLCs have to answer to stockholders
  • PLCs are required to disclose their financial information as they trade stock.

If you’re interested in setting up a limited company, then check out our article on “becoming a limited company”.

Partnership

A business partnership is where you share the financial responsibility of your business with a partner(s). It can be split into an ordinary business partnership, limited partnership and a limited liability partnership. Each one basically sets out the liability. An ordinary partnership has the same financial implications as being a sole trader – you are personally financially liable for the business. A limited partnership is a little different as general partners are only financially liable up to the amount of money they have initially invested. Limited liability partnerships (LLPs) have no personal liability for debts and their financial liability is limited to the amount they have invested in the business. If you want to learn more about how partnerships work, check out “Setting up a business partnership”.

Partnerships allow you to share all your business profits between the business’ partners. Each partner will then be taxed on their dividend. Depending on the nature of your partnership agreement your tax responsibilities will vary. In general terms, a partnership can be very beneficial and is a common extension from originally being a sole trader.

Advantages

  • Financial responsibilities are split
  • You have more than just yourself to consider where the running of the business is concerned
  • Greater potential to raise more finance

Disadvantages

  • Partners might not agree on certain subjects
  • If you’re in a standard partnership you are still liable for company debt

To discover which legal structure suits you and your business best, please read our more in-depth articles. Once you’ve decided which way to go you may need to register your company, all of which is also explained. Choosing a suitable structure should be very simple even though it may require much thinking. However, one structure will always stand out as being the correct one.