When setting up a company, there are three primary models to choose from, most notably that of a sole trader, a limited liability company or a partnership. The sole trader or partnership model do not allow the business to be owned by a separate legal entity or provide limitation of exposure to the debts and liabilities of the business in a way that a limited liability company does. Each structure has varying characteristics and distinct advantages and disadvantages. As you will see, there is no simple answer to the question of which type of business structure to choose from and one size definitely does not fit all.
LEGAL FORMS OF BUSINESSES
- SOLE TRADER
A sole trader effectively starts a business without forming a company and is a popular way of starting a new business in the UK. It tends to be particularly common amongst those going into business on their own for the first time. The primary benefit is retaining full control over your business as you are essentially ‘your own boss’. Other key advantages include low start-up costs, less statutory obligations, simplified accounting, profit retention and privacy (as there is no requirement to publish accounts). In addition, a sole trader can elect to form a limited company at a later point. In terms of disadvantages, as sole trader businesses are not recognised as separate legal entities, liabilities and debts are personal debts. Other disadvantages include the perception that sole traders are seen as ‘higher risk’ and a perceived lack of prestige.
- LIMITED LIABILITY COMPANY
A limited company is a separate legal entity, distinct from its shareholders and directors. This means that third parties contract with the ‘company’ and not individual directors and shareholders and as such it offers the protection of limited liability which means your risk of loss is ordinarily limited to the funds invested in the business. Other benefits include the perception of prestige and permanence that a limited company possesses as this gives customers a sense of confidence as in reality many larger businesses will not deal with an entity that is not a limited company, taxation benefits as corporation tax as opposed to income tax is payable and dividends can be paid to shareholders, greater options when raising new capital through share classes, company name protection and setting up as a limited company provides a strong base on which to expand and develop. However, on the downside, compliance with the Companies Act 2006 is required on an ongoing basis, company information is on public file and significant costs are involved in complying with administrative and statutory burdens (including the annual filing of returns and accounts).
With an ordinary partnership, no limited liability is available and each partner is effectively liable for the business debts of the partnership (and the Partnership Act 1890 will apply if no partnership agreement is entered into which can have quite severe consequences). Whilst, trading as a partnership may be a beneficial way for two people to set up a company, as the business expands it may be more appropriate to form a limited company to avail of limited liability. Alternatively, a limited liability partnership (LLP) offers its members protection from partnership debts and liabilities and is in effect a hybrid between an ordinary partnership and a limited company. The administrative burden is, however, much greater and registration with Companies House is required, as is the filing of annual accounts and compliance with the Limited Liability Partnership Act 2000.
Therefore, when deciding on which type of company to set up, it is important to make an informed decision, as this will have both practical and legal implications and may have significant consequences in terms of costs, responsibilities and potential liabilities in the future.
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