Company formats and business structures explained

A business' legal structure determines who makes the management decisions, how much tax you'll pay, what records you need to keep, who has financial liability for the business and how you raise money. In short, make sure you register under the right structure and company format; get it wrong, and it could be an expensive and complicated mistake to rectify. If you are in any doubt, speak to a solicitor for advice.

Sole traders

  • Sole traders make up a huge proportion of businesses in the UK. They are typically self-funded, one-man enterprises working from home, or out of a van, without any employees.
  • Registering as a sole trader gives you the independence and freedom to run your business how you want, without red tape, or having to file accounts with Companies House. However, it does mean you don't have the support of a partner, or board of directors, to give you guidance during the tough times.
  • To register as a sole trader, you must first register as self-employed. The business owner, and the business itself, become the same legal entity - which means you are legally and financially responsible for the business. If it runs into trouble, so do you.
  • As the business owner, you keep all the profits. You will then pay tax and fixed-rate Class 2 and 4 National Insurance contributions (NICs) on those profits and fill in a yearly self-assessment tax return.
  • There are no directors for the business, so you make all the management decisions. You can raise finance from bank loans or personal assets, but you will be responsible for ensuring those loans are paid off.
  • You can read more about the business structure, sole traders in our Smarta guide, here

Partnerships

  • Running a business can be a lonely thing to do, particularly during the tough times. Registering as a partnership allows you to share costs, responsibilities and risks with another person. In return, you'll have someone to support you, and help you make the important decisions.
  • Like a sole trader, all partners will need to register as self-employed. Partners make all the management decisions without interference from a board of directors.
  • Make sure your partners are completely trustworthy: all partners are equally financially responsible for all debts incurred by the business. This means if the business runs into trouble, creditors can claim personal assets from you to pay off debts, even if those debts are incurred by another partner - and even if you invested less than another partner.
  • It's up to the partners what share of the profits they take, but both the partnership and each individual partner will need to fill in a self-assessment tax return and return it to HMRC. You will be required to pay taxes on your share of the profits, as well as Class 2 and 4 NICs.
  • It's worth bearing in mind that while you can use HMRC's free software to fill in SA tax returns for individuals, you'll have to fill in the SA tax return for the partnership, as a whole, either manually or using commercial software.  It's best to seek advice from an accountant - if you get it wrong, the business and each of its partners will incur a fine.
  • Read more about the company format of partnerships and whether it's right for you, in our Smarta guide, here

Limited companies

  • Limited companies and their owners are separate legal entities, which means while you are responsible for the business, you won't incur losses if it runs into trouble.
  • Once you register a limited company, you become an employee and a shareholder. The owners can then draw a salary as well as dividends. Depending on how you structure this, it can be more tax-efficient than a sole tradership, where the owners keep the profits.
  • Owners of limited companies and LLPs are not legally or financially responsible for the partnership. If something goes wrong, creditors can seize assets from the business but not from its owners - unless you have secured a loan against personal assets.
  • Limited companies and must be incorporated at Companies House and must have at least one director. You will then need to undergo an annual audit and file your accounts with Companies House each year.
  • As a director of the company, you will pay income tax on the salary you draw as well as being taxed on any dividends you take. You will also pay Class 1 NICs.
  • The company itself will be expected to pay corporation tax of 19% for all profits - except ring fence profits - or the 20% special rate for open-ended investment companies and unit trusts. (See HMRC's Corporation Tax rates table for more information).

Limited liability partnerships (LLPs)

  • LLPs limit the amount of liability its partners have for the company to the amount they have invested in it, which means creditors can only seize the business' assets, rather than partners' personal assets if the business runs into trouble.
  • You can register as many partners as you like, but each partner must register as self-employed and, as with an ordinary partnership, you will have to fill out a self-assessment tax return for the partnership as a whole, as well as for each partner.
  • Unlike an ordinary partnership, an LLP must register two designated members with Companies House. Designated members are responsible for appointing an auditor, signing and delivering accounts to the Registrar; notifying the registrar of changes to the partnership; delivering the annual return and 'acting on behalf' of the LLP if it is wound-up or dissolved.
  • If one of the designated members leaves, the rest of the partners are automatically deemed to be designated members.
  • LLPs must be incorporated at Companies House, undergo an annual audit and file their accounts with Companies House each year.
  • As a director of the company, you will pay income tax on the salary you draw as well as being taxed on any dividends you take. You will also pay Class 1 NICs.
  • The company itself will be expected to pay corporation tax of 19% for all profits - except ring fence profits - or the 20% special rate for open-ended investment companies and unit trusts. 

Franchises 

  • Franchising is the most low-risk way of starting a business, and is ideal for those who don't have a clear business idea. 
  • Franchising involves one company granting another, a license to sell their product or service.
  • It is common that you have to pay for this license and go through a series of interviews before it is granted to you. 
  • The franchisee (the individual who is granted the license) is usually placed under strict restrictions. 
  • The franchising industry is very lucrative, employing upwards of 600,000 people in the UK. 
  • There are multiple types of franchising, the most popular of which is business format franchising where the franchisor grants people to sell a product under their trade name, but retain control of the business. 
  • Licensee franchising is where the franchisor does not control the business at all.
  • In distributor and dealership franchising, the product is sold by a third party, but not under the franchisor's company name. 
  • You can read more about the franchising business type in our Smarta guide, here.

Checklist

  • Decide how much responsibility you want to take for the business. If you can afford to be financially responsible, a sole tradership, or partnership will offer more flexibility, whereas a limited company or LLP may have tax advantages.
  • Partnerships and LLPs will need to make sure they fill in a self-assessment tax return for themselves as well as for each of the partners.
  • Individual partners can fill in their SA tax returns online, while the tax return for the business itself must be filled in using commercial software or by hand.

FAQ

What happens if my partner leaves or dies?
If a partner dies or leaves the partnership, the business can carry on trading but you must dissolve the partnership immediately.

If I choose the wrong structure, how easy is it to change?
Your solicitor should be able to help you change the structure of the business relatively easily. However, it can be a costly exercise - so think carefully before you decide which format to register your business under.

How do I take on a new partner?
If you decide to take on a new partner, they need to register as self-employed and, if you have an LPP, you'll need to register them with Companies House. Your solicitor or accountant should be able to advise you on the best course of action to take.

Jargon buster

Silent/sleeping partner: a sleeping or silent partner invests money in the business but doesn't take part in its day-to-day running. They can take a share in and pay tax on the business' profits.

Partnership agreement: a partnership agreement is a contract drawn up before you enter into a partner dictating how it is run. It's designed to resolve any disagreements between partners. Make your partnership agreement as water-tight as possible before you enter into a partnership to prevent disputes from breaking down the business.

Smarta Formations

If you are looking to form your own business, then you can incorporate with us today in under 10mins, with the potential to be trading within 24 hours - all from £9.99. If there's a need to trade urgently, then why not use our express service so you can be up and running within 3 business/working hours.

Find out more about Smarta Formations.

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