In the UK, there are four main types of business entities for small businesses:
- Sole Trader
- Traditional Partnership
- Limited Liability Partnership
- Limited Liability Company (Ltd).
There are also community interest companies (CIC), charities and public limited company (Plc).
Deciding which business entity you are going to use is important and can be difficult. That is why we have researched the advantages and disadvantages of these various business entities for you. This should make it easier to pick the right choice for your enterprise.
Making this decision will bring you a step closer to ensuring your business’ productivity in a competitive environment.
A sole trader or sole proprietorship is a business, usually with one owner, which is not deemed to be a legal entity or company.
The owner of the sole proprietorship has total responsibility for both the profit and debt of their business.
There are a number of pros and cons associated with this form of business;
Minimal setup and administration requirements – In the UK, sole proprietorships don’t need to register their business name at Companies House. Instead, you should notify HMRC to calculate your personal tax.
Fewer regulations and less filing – There are no annual returns to complete, no statutory records to maintain, no statutory accounts to prepare, and no separate corporation tax returns to submit. Any profit the business makes is seen as your source of income. This will require you to continue paying your income tax and file a personal annual tax return.
Save money – With fewer regulations and less tax on your business, you will be able to save business expenses. Furthermore, as you technically are in self employment; any profits made will be solely for you.
Flexibility – Being the sole business owner of an enterprise that isn’t a legal entity gives you complete control over everything in your business.
The debts of the business become the owners’ responsibility to pay – As sole proprietorship, you are personally liable for any debts the business experiences. You alone take on the risk of your business’ debt and legal actions. Your personal assets are not separate from your business assets, meaning they can be required as collateral. There is no failsafe, unlike a limited company.
Losses can affect your personal assets – Sole proprietorships lack the prestige of being a registered company.
Many sole proprietorships change their business structure, as they expand, to business structures less liable to change – such as a limited or limited liability company.
Consider reading Sole Trader vs. Limited Company: Top 10 Considerations if you are unsure which to pick.
A partnership is a business with two or more people. In the UK, there are two types of partnership: a traditional partnership and a limited partnership.
General Partnership (Traditional)
A traditional partnership is similar to a sole trader, but with more owners. As a general partner, every proprietor has a stake in the ownership of the entity. Again, it is not considered to be a legal entity.
This type of entity also has a number of pros and cons;
General partnerships benefit from the same pros as a sole proprietorship.
However, the personal liability is shared among the owners. Therefore, slightly mitigating the worst-case scenario of an indebted sole proprietorship.
Maximising experience – One of the reasons you might be looking for a partnership is because you have an experienced partner. Both parties could have experience in different sectors of business. A partnership can effectively combine your experiences. They often make a far more effective enterprise than being a sole proprietor.
Tax – Traditional partnerships are not seen as a company and therefore don’t pay corporation tax.
General partnership has the same cons as sole proprietorship.
However, the profit made from the business is shared among the owners.
Debt – If one member of the general partnership has incurred debt in the business due to their own faults, every partner is responsible. This is often known as joint liability and can affect the personal assets of both partners.
Internal conflict – Many general partnerships fail because of the conflicting personal interests of one partner or the other. This lack of cohesion can be detrimental to the business causing it to fail.
Limited Liability Partnership
Limited Liability Partnerships are businesses registered at Companies House. They consist of two, or more, proprietors who share the profits of that entity.
This type of business is often profit-driven and used by professions such as law and accountancy.
There are also a number of pros and cons associated with this type of business;
The owners of limited partnerships (LLP) are only personally liable to pay up to a certain amount of debt. As a separate legal entity, the rest of the debt falls on the company. This will protect owners from potentially devastating losses.
By only taking on limited liability, owners of the LLP can afford to take business risks to grow their business faster and larger.
Limited liability partnerships do not pay corporation tax in the UK.
Similarly to a traditional/general partnership, LLPs maximise its efficiency through the experience of each member. However, it is important to choose the right partner, a feat difficult to do without planning.
Lack of flexibility
Limited partnerships must agree on decisions. You cannot choose your company name and you cannot do what you want as there are other owners and directors besides you.
The busienss entity has to, for example, file annual accounts, complete annual returns, and approve the business’ financial statements. This is not the case for unincorporated businesses.
Limited Liability Companies
A limited liability company LLC is the most common form of company in the UK. As a business entity a limited liability company is considered, in the eyes of the law, as its own “legal person”. This offers the owner limited liability.
Limited liability means the owners are not personally responsible for the losses and debts of their enterprise.
Limited liability companies come in two forms:
1) Private limited companies
2) Public limited companies
If you are thinking of starting a small business, or taking your freelance work to a larger scale, then you’ll likely start with a private limited company. However, if your company grows large enough, you can always convert to a public limited company through a process called an initial public offering (IPO).
Private Limited Companies (LTD)
The shareholders of a private limited company are those who own the company and predominantly control it. When the company is private, the shares are all owned by a select few. If you alone are starting an LTD, you will likely be the sole shareholder and have complete control over the company. Of course, this still is within the legal boundaries of an LTD.
As is implied in the name “limited liability company”, the main purpose of the company is to protect the shareholders’ and directors’ personal wealth. If the company incurs a debt, only the assets of the company can be taken.
Setting up and running a limited company where you are both a director and a shareholder is one of the most tax-efficient ways of working. For example, you can take earnings from the business as a combination of salary and dividend which limits the amount of tax you’ll personally pay.
Setting up an LTD can take as little as 10 minutes using apps like MachFast.
Transparency in Business
An LTD’s filing history is made public on the Companies House register once it has been incorporated. Other parties are therefore more confident when doing business with LTDs as opposed to other types of business entities.
The company must have a registered office in the UK. Government regulations on company names apply. There must be at least one share issued during the creation of the company.
LTDs have to pay corporation tax which is set at 19% in the UK. Although this is more tax being paid than a sole trader, the UK has the lowest corporation tax out of the G7 countries.
Like with the other types of incorporated companies, you’ll be required to file things. This includes annual accounts, annual returns, and approve financial statements.
Once you have decided which business entity is best for you, you should start creating a business plan.
Our blogs give helpful information on forming business plans as well as other useful information on How to start your business on a limited budget for example.
As you can see, the type of business entity you choose to register your business as will depend on a number of different decisions including; whether or not you wish to be financially responsible for the profits and losses of your company, whether or not you wish to rely on compromise for big decisions and the amount of paperwork you wish to be required to submit.
Considering these various elements will allow you to ensure that you register your company as the right form of business and benefit from the variety of pros that type offers.
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