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Which business structure should you choose for your new business – sole trader, limited company, partnership or LLP?

September 27, 2011

The type of structure you use will depend on a number of factors unique to the business you want to start. In this article, we look at the main structures – sole trader, limited company, partnership and LLP and highlight the pros and cons of using each one.

Sole Trader

The simplest, most ‘hassle free’ way of starting up in business is as a sole trader (otherwise known as being ‘self employed’).

You need to inform HMRC of your intentions to become self employed (or soon after you have started up), and will have to complete a self assessment tax return each year. You pay income tax and Class 2 / 4 National Insurance Contributions on any profits your business makes.

Unlike the limited company structure, sole traders do not have the luxury of limited liability in case something goes wrong – any business debts you incur, for example, will be counted as personal debts.

Partnership

Two or more self employed may decide to work together and set up a partnership.

As with sole traders, partnerships do not enjoy the benefit of limited liability. The partners will share in all aspects of the business – both in terms of any profits the partnership makes, but also in terms of liabilities – which are shared.

It is very important that you sign a partnership agreement if you decide to go down this route. The partnership agreement should cover important issues such as how the business will be run, how the profits are to be split, and what happens if a dispute arises between partners.

Limited Liability Company

There are over 1.1 million limited liability companies in the UK.

Unlike the sole trader structure, a limited company is a distinct legal entity from its directors and shareholders.

Shareholders are only liable for the amount of money they have invested in the shares.

Company directors have limited liability, although if you provide personal guarantees in order to secure business finance, you will have some personal liabilities.

Limited company directors have a number of legal and financial obligations to meet, including dealing with Companies House – the registrar of companies in the UK.

You will be liable to pay Corporation Tax on any profits the company makes, and complete an annual self assessment return for the income you personally draw down from your company.

A limited company may provide a more professional image for your business, and in some cases (such as IT contracting or Interim Management), you may not be able to operate as a sole trader.

The costs of incorporation are not high; you can set up a limited company for under £50 these days but operating as a limited company is more expensive than being a sole trader (mainly due to higher accounting fees).

Limited Liability Partnership (LLP)

A limited liability partnership shares some elements of both the limited company, and the partnership model.

The LLP is a distinct legal entity, like a limited company, and is governed by Companies House.

In order to form an LLP, there must be a minimum of two members, which can be individuals or businesses.

You should draw up a Deed of Partnership to outline how the LLP is to be run, and detail the roles and responsibilities of its members.

The LLP model is relatively flexible, and members are taxed directly, via the self assessment route.

Many accountancy and legal firms use the LLP structure, although it is not widely used by small businesses or start-ups.

Further Information

Unsurprisingly, there are no strict rules to determine which business structure you should choose for your start-up. We would highly recommend discussing your options with an accountant or other professional, and don’t use the information included in this article as a substitute for professional advice.