When you decide to start a business, one of the key decisions you’ll have to make is in determining the legal structure it will have. The three major types of businesses fall into one of either sole trader, limited company or partnership. There are pros and cons associated with each of these, and the type, size and complexity of your business will lend a strong influence towards which legal structure might suit it best.
Just some of the differences between these legal forms include the admin and paperwork required to officially create the business, whether you as an individual are protected under the umbrella of limited liability, how taxes are reported and how any profits can be divvied out.
We’ll look at each of these three legal structures one by one:
Sole Trader – As the name implies, when you operate as a sole trader you’re trading as an individual, and any post tax profits that your business generates is yours to keep and do with as you like. Similarly, as a sole trader you are personally responsible for any losses your company incurs, and to settle any debts/expenses that the business racks up. There is no “limited liability” protection, as is afforded when you set up a limited liability company.
The key responsibilities for the sole trader include filling out and returning a self assessment tax return, and making income tax and national insurance payments. If your business earns revenues exceeding a certain amount, you will also have to register your business for VAT.
While sole traders operate as individuals, they often do hire people within the business. The sole trader business structure tends to be the simplest legal entity to do business as.
Limited Company – The most stark distinction between a sole trader and a limited company is that the limited company is a unique and distinct entity within its own right. While there is much fluidity between the personal finance of a sole trade, and the finance of the business he or she runs, this is not so for the limited company, which will have separate bank accounts to the individuals that set it up.
When the limited company generates a profit, it is the company’s profit – the management of the company (typically the directors) will decide on how any profits will be used.
One of the biggest advantages of setting up a limited company is the protection of limited liability – the directors and shareholders who set up and run the company are not personally responsible for any debts that are unpaid.
Limited companies are owned by shareholders who each have a stake based on the number of shares they own. Often, the directors who manage the company will have some level of share ownership.
The main responsibilities for the limited company will include preparing statutory accounts, sending these accounts to Companies House each year, and preparing an annual tax return to HMRC. If the company incurs takings beyond a certain level, it must register for VAT.
Business Partnership – This is when two or more people set up a business and share both the operational responsibilities and the profits. In essence, it shares many traits with the sole trader structure, in that the partners are fiscally responsible as individuals for any losses generated, while profits are shared between partners according to any agreements drawn up.
The key responsibilities levied on partnerships include submitting a partnership self assessment tax return annually – each partner must submit a personal self assessment tax return and pay income tax and national insurance as appropriate. Partnerships must also register for VAT when their takings exceed a certain point.