Which Business Structure Should I Use ?
Here I look at the different business structures you can trade through. Your business format is not set in stone forever and you can change between them. It is fairly simple for a sole trader to take on a partner and become a partnership and for a partnership to become a limited company. There are however more complications with changing from a limited company to a sole trader or partnership.
This is the simplest form of business to start where you carry on business on your own account. You are liable to income tax and Class 4 National Insurance on your profits. You can employ people including your spouse, as long as they are paid only for the value of work actually performed.
A limited company is a separate legal entity from its owners. These are the basic facts…
- The business is owned by the limited company, not you.
- The company must have at least one shareholder.
- It must also have at least one director. There is no longer a requirement for private companies to have a company secretary.
- The shareholders do not have to be directors. Directors are treated as employees of the company, but they do not have to draw a salary form the company.
- If you are the only shareholder, you will have sole ownership of the company, and are likely to also be the director who runs it.
- The company pays corporation tax on its profits.
- The company is governed by company law.
Main advantages of using a limited company...
- A limited company may appear more credible and substantial although in reality this is not necessarily the case.
- The liability of its shareholders is limited to the amount of the share capital issued and so offers protection to the shareholders’ personal assets. In the event of company failure and not being able to pay its creditors, your personal assets are protected. However, banks, landlords and others will often require personal guarantees from the shareholders or directors when dealing with small limited companies.
- A limited company has better borrowing potential than an unincorporated business as it can use current assets as security by creating a floating charge over its assets.
- You can use shares to enable different people to hold different proportions of ownership of the business that they can pass onto the next generation.
- You can have different classes of shares with different rights, such as non-voting shares for someone who wants to invest some money into the company but doesn’t wish to take part in the management.
- Having a limited company can create significant tax advantages by having profits taxed at Corporation Tax rates which are a lot lower than the higher rates of personal tax. However when the funds are extracted from the company extra tax or national insurance charges may arise.
Main disadvantages of using a limited company...
- It is far harder to take money from the business than a sole trader or partner. As a Director you are an employee of the Company and must operate PAYE and take a salary with tax and national insurance deducted.
- As a Shareholder you can take money as a dividend IF the company is making a profit but with effect from April 2017 only the first £2,000 are tax free making it far less attractive for one-man Companies than in earlier years.
- Your annual accounts have to be filed at Companies House and are available for public inspection as is other information about the company.
- Directors are personally subject to regulations and can be fined or found guilty of a criminal offence for failing to comply.
- A company is more complicated to wind up.
- Generally involves higher accountancy fees as there is paper work to deal with.
- Any losses made by the company cannot be used against the owner’s other income.
The best business structures are those that are as flexible as possible. A new business that is likely to make losses in the first few years could start as a partnership or sole-trader to make the best use of those losses. There may be commercial pressures to operate as a limited company in certain sectors. It is possible to split a business into two; one part running as a limited company and one as a sole trader/partnership to get the best of both structures. However the VAT implications of such a split must be considered carefully.