If you are thinking about setting up a business or going self-employed, one of your key considerations should be your business structure. Popular ways to set up your business include: sole trader; partnership; and company. The structure you choose should depend on careful consideration of your goals and circumstances, including:
- the size of your business;
- how much profits you expect to make;
- how much risk you are prepared to accept;
- your other income; and
- whether you have family you can involve.
A sole trader, as the name suggests, is where you are set up on your own and is the simplest structure. This may suit a small, simple business, with relatively low income levels ( perhaps below the main rate of income tax). Common examples of people who set up as sole traders include ‘one man band’ businesses such as folk involved in the construction industry who want to be self-employed. Generally the set-up costs of sole traders are low, compared to companies and partnerships.
As a sole trader, you keep all of your profits and are in sole control of establishing and running the business, however a big downside is that you have unlimited liability. Unlimited liability means that your personal assets may be used to repay the debts of your business! With a sole trade you may also have less flexibility in tax planning opportunities compared to a partnership or company structure.
A partnership is a structure where you and at least one other person combine to run a business together. A partnership agreement is commonly created to define who is involved, profit sharing, and salaries, and this can make it more expensive and complex to set up than a sole trade.
As a partnership, profits can be shared as the partners agree (this may also afford some tax planning opportunities), as stated by the partnership agreement. Like a sole trader, each partner in an ordinary partnership has unlimited liability, meaning that any partner's personal assets may be used to repay debts of the business.
People often set up partnerships to include their spouse or adult children. This allows more flexibility in sharing profits and managing personal taxation arrangements. For example, profit sharing arrangements may be structured in a way that utilises a partner's unused personal allowance or basic rate band, as long as this reflects the individual partners' contributions to the business. This can be especially beneficial to businesses with significant profits, or where partners have more exposure to higher tax rates.
It is worth noting that good relations between partners is very important. Conflicts arising between partners, whether it be a family partnership or a purely business relationship, could have a knock on affect on your business performance, or even lead to an expensive break-up of the business, therefore trust is essential to effective parftnership working.
Limited liability partnerships (LLP's) may be a useful alternative to ordinary partnerships where partners wish to limit their financial exposure whilst benefitting from the other benefits of this type of structure.
You might also consider incorporating your business by forming a company. As a shareholder in a private company limited by shares, your liability is limited, in most circumstances, to any unpaid share capital. This means that any assets you own personally cannot normally be used to repay debts of the company, unless you have provided personal guarantees in respect of the company's liabilities.
One of the main potential benefits of setting up your business as a company, is the potential this offers to plan and manage tax exposures. This applies particularly where trading profits are likely to be fairly significant, and if you have family employed in the business. Profits may be extracted from a trading company in a variety of ways including wages, dividends and employer pension contributions. If the company uses your own premises or other assets, you can also consider charging the company rent, subject to personal Income Tax and Capital Gains Tax considerations. This will again depend on your own circumstances, but a key point about companies is the flexible tax planning opportunities they offer, relative to other business structures.
Of course, there are also some drawbacks to a company structure. It is likely to be more expensive to form a company than a sole trader or partnership. The accounts, which must comply with the Companies Act, are held on the public record (albeit only limited information for small companies), there are stricter rules governing the running of the company and preparation of accounts, and there are still some circumstances where you may be personally liable for the company’s debts.
In summary, there is no "one size fits all". How you choose to set-up should depend on careful consideration of issues including the level of profit you expect your business to make, your other earnings, your family’s circumstances and the amount of liability you are prepared to risk. If you are setting up a business, or are unsure if your current set-up is right for you, contact us today for a free consultation.