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An introduction to startup business structures

19 Jan 2017

 

The legal aspects of running a business can seem like a burden unless you know your way around the basics, and how the law affects your particular business model. The Companies Act 2006, which provides the primary source of UK company law, remains one of the largest UK acts of parliament, yet still only plays a small role in the legalities involved in running a UK business. Consideration must be given to other areas including consumer, intellectual property, contract and employment law, to name just a few.

 

Business Form

 

When starting a business you need to consider what form it should take. This depends on your business area, how you intend on running your business and who with. One form may be suitable to start, but as your business grows, you may need to rethink its structure to make the most of the options out there. There are four common forms a business can take, each having advantages and disadvantages.

 

Sole trader
 

There are several benefits of launching your business as a sole trader. There are no fees associated with running your business in this form, so it is well suited to those wishing to keep startup costs down. This business form is common for individuals operating in the service sector, for example photographers, hairdressers and construction jobs.

 

Running your business as a sole trader offers you the ability to make instantaneous decisions without the need to involve others, and any profits you make belong to you. As with all business models, there is an element of risk when running your business in this way. Most notably, there is no distinction between you and your business, and you will personally be liable for any debts that your business accrues. This contrasts with the position of running a limited liability partnership or company.

 

As a sole trader, you register as self-employed and complete an annual tax self-assessment. Your profits are taxed as income by HMRC, similar to being an employee of a company. As your income increases, so does your tax liability. When income from your business and any other revenue streams reaches the higher rate tax bracket, you will be liable to pay 40% on it.

 

Operating as a sole trader is great for businesses just starting up. There is little paperwork involved and the administrative burden is relatively light. However, be cautious of commitments you make in the name of the business, as you will be personally responsible for meeting them. Ultimately, one of the greatest risks of running a business in this manner is bankruptcy. This is an inability to cover your debts from your personal funds. As you will come to note, other business forms provide tax benefits and reassurances against the risks associates with running a startup business. Having support in decision making processes, and the ability to protect yourself and your personal assets against any claims will go a long way in guarding yourself and your business.

 

Limited companies
 
Incorporating your business as a company is the process of registering your business with Companies House (the UK’s registrar of companies). The registration process has become far less daunting in recent years. Technology has simplified the process, and reduced the cost and time it takes to register. In addition, the requirements have become less stringent, and a single individual can now act as the sole director and shareholder (or ‘member’). There are a number of organisations that can support you through the registration process, some examples include Companies Made Simple and 1st Formations.
 

Most Limited companies are limited by shares. This means that the shareholders’ responsibilities for the company’s financial liabilities are limited to the value of shares that they own but have not yet paid for. Note however, there are situations where a director of a company can be personally liable for the debts or actions made in the company’s name. This is often the case where there has been deliberate wrongdoing by a director, and has attempted to hide behind the protection afforded by the limited liability status of that company.

 

Provided there is no deliberate wrongdoing in your capacity as a director, then there is significant protection and security which is provided by company registration. Your personal finances and assets are protected, and considered separate to your company’s finances. This is because you and your company are treated as two separate legal entities.

 

Unlike sole traders, companies pay corporation tax. The current corporation rate is 20%. The directors pay income tax as they are treated as employees of that company.

 

There are a few filings a company must make to comply with the legal requirements of running a company, in particular, the annual filing of statutory accounts and annual return to HMRC. Smaller companies (with turnover less than £5.6 million) can submit an abbreviated version. You will also be responsible for paying employees’ income tax through the pay as you earn (PAYE) system, and National Insurance Contributions (NIC). You can manage these filing and payments yourself, however it is always worth considering hiring an accountant to manage these processes for you, as errors, omissions and late filings can result in penalties being levied on your company.

 

Partnerships
 
Creating a partnership can be an attractive option if you intend on running your business with someone you know and trust. Partnerships and sole-traders have common attributes, however the decision-making process, and the liabilities associates with running a business, are spread across two or more people. Having a business partner to assume responsibility of the business in your absence also compensates for periods of leave or sickness.
 

To promote a successful partnership, a formal, written agreement needs to be established between all partners. The partnership agreement should be legally enforceable and binding, and detail the position with regards to ownership, financial contributions, liabilities, apportionment of profits, and the outcome of the business in the event one or more partner leaves. Each partner should be registered for self-assessment tax in their own name. Otherwise, there are no further legal requirements associated with running a business in this form.

 

In a standard partnership, all partners are joint and severally liable for the acts or omissions of the other. This means that you could also be liable for the debts and actions of your other business partners, an important consideration when running a business in this matter and when preparing your partnership agreement. To overcome this, you can limit your liability by registering your business as a limited liability partnership.

 

Limited liability partnerships
 

Limited liability partnerships are a great option for professional service firms, providing a hybrid form between a limited company and a standard partnership. As with companies, this business model protects the individual partners from personal liability, to the extent that any personal contributions and guarantees they have invested into the partnership.

 

Limited liability partnerships must register with Companies House. Partners’ profits are taxed as income, with each member registering to HMRC for self-assessment. A clear and concise partnership should exist between the members covering, amongst other matters, the profit ratios payable to them.  

 

This model is favoured with many UK professional services firms, and can have significant appeal to businesses wishing to grow operations by recruiting additional partners.

 

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