The right business structure can mean the difference between a successful and unsuccessful business. Here’s a basic overview to help you determine which is right for you.
Over the years, I’ve helped numerous clients save money on taxes, increase profits and build their credibility by guiding them through the process of choosing the right business structure for the stage they’re in. The right structure at the right time can mean the difference between a successful and unsuccessful business.
There are various types of structures for a small business, all with benefits and drawbacks. Some of the most common are sole traders, partnerships, limited liability partnerships (LLP), and limited companies. We’ll take a look at each structure so you’ll have a better idea of what makes sense for you. Of course, a professional can advise you best, but it’s good to have a basic overview.
A Quick Tour
If you’re the only one responsible for the business, you can choose to run it as a sole trader. It’s easy to set up as a sole trader, and you’ll have complete control over the business. You keep the profits of the business, after you’ve paid tax on them. On the flip side, you’ll also be liable for the business debts, meaning if anything goes wrong, your personal assets could be at risk.
If you have one or more partners who are also responsible for the business, you can set up a partnership. The profits are shared between the partners, who pay tax on their portion. But just like a sole trader, the partners are liable for business debts.
Limited Liability Partnership
A LLP is an alternative business option that brings all of the benefits of limited liability, it also allows the flexibility when organising an internal structure. In an LLP, one partner is not responsible or liable for another partner’s misconduct or negligence.
A limited company is a corporation. When you set up a corporation you are creating an entity that is separate from your personal finances, which isn’t the case with sole traders and partnerships. This separation offers some key benefits, such as:
- Limited liability: As an owner, your assets will not be affected if the company were to get into financial trouble, except when you’ve signed a personal guarantee.
- Tax efficiency: Corporate tax rates are lower than the highest personal tax rates. This means that if profits reach a certain threshold, a corporate structure would allow you to pay lower taxes compared to a sole trader or partnership.
- Funding: It’s much easier to raise funds through a limited company and different classes of shares means you can offer investors different rights to dividends, and have different amounts of control over the company.
With incorporated structures, there are extra responsibilities that company directors have. Directors must abide by the Companies Act 2006, and must exercise reasonable skill, care and diligence. Directors must also act in the interest of the company and not themselves. Limited Companies are also required to keep very good records, more so than a sole trader or partnership. This is the director’s responsibility and failure to do so can see the director held personally accountable.
When Should You Incorporate?
For many first time business owners, starting as a sole trader is usually the easiest option because it’s pretty simple to set up. A sole trader may want to incorporate down the line, as the business gets bigger and is making reasonable profits. At this stage, there is obviously more risk is involved and incorporation can ensure personal assets are protected. There are also tax savings that can be made on incorporation. It’s wise to consult a professional to help guide the decision, since there are many factors involved.
How Do You Incorporate a Business?
You can incorporate your business at any time by applying to Companies House. Typically a speedy process—most companies can usually incorporate within 24 hours. It could, however, take longer if Companies House objects or needs additional information from the applicant.
You can apply using old-fashioned pen and paper forms, completed and returned to Companies House. Unless you are a public company, you can also apply online through the Companies House Web Incorporation Service.
There are costs associated with incorporation, ranging from from £30 to £200, depending on whether a business owner tackles things solo or hires a professional. Some businesses choose to use a formation agent to help guide the process and handle the paperwork. Having a reputable agent carry out the process ensures all documentation is prepared correctly.
The Difference a Year Makes
Because a corporation is a separate entity, it will have its own financial year, based on the day you incorporate. This financial year can create some complex issues because there are other “years” that come into play when doing accounting and tax planning, namely the personal tax year (April 6 through April 5) and the corporate tax year (April 1 to March 31). To make things easier, many companies align their financial year-end close to the tax year-ends, which allows you to complete all accounting, payroll and tax work at the same time, rather than staggering the work throughout the year. However, because things can get quite complicated, a professional advisor can help make sure you’ve got the best arrangement set up.
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