Legal Structures of Businesses

All too frequently, a new business is established with little consideration for the practical implications. Many entrepreneurs set out on new ventures, excited (as they should be) by their idea but without having thought through the responsibilities that running a business entails.

One of the most important considerations that must be addressed is the legal structure of your business; this will have far-reaching implications, and should be dealt with at the earliest opportunity.

Sole Traders

If your company consists entirely of you, it may well be that you have been operating as a sole trader for some time. This is the most basic legal structure available to a business. Essentially, as a sole trader you are the business; in the eyes of the law, and the Inland Revenue, your new business is not a separate legal entity from its founder.

This means that you have the freedom to make all management decisions, as well as the ability to raise finance yourself, whether this is from your own assets or through third party investment. From a tax standpoint, there are no distinctions between the position of a sole trader and a self-employed individual; you must register as self employed with HMRC, and must complete an annual self-assessment. All business profits are counted as part of your personal income, and are taxed as such.

The significant drawback of the sole trader position, however, is that you are personally liable for any debts that may be run up by the business; there is no legal separation between your personal liabilities and those of the business.

Partnerships

If you are going into business with another person, you might consider forming a partnership in law. Under this arrangement, both you and your partner will both have to register as self-employed, and the profits will be counted as both of your personal incomes. The same taxation rules apply as for a sole trader, but the liabilities are split between you and your partner.

Limited Liability

In order to mitigate your financial liabilities, you may consider establishing your company in a manner that provides you with ‘limited liability’. Under these arrangements, your own exposure to the financial liabilities of the business is limited.

This can be achieved regardless of the number of directors or partners; a Limited Liability Partnership takes the basic structure of the partnerships detailed above, but separates the business as a discreet legal entity. This means that your personal liabilities are limited to your own personal investment, while your partner’s position will be the same. Similarly, a limited company is run by one or more director - probably you. These individuals have no liability further than any personal investment that they make in the company.

There are, however, a number of disadvantages to Limited Liability Partnerships and limited companies. In the first instance, you will be required to file annual accounts with Companies House, on top of your existing responsibilities. Furthermore, you are likely to have to pay yourself via PAYE; this can be inefficient from a tax point of view, as you will have to make employer’s and employee’s National Insurance Contributions. As such, it is vital that you seek advice from a solicitor and accountant before you incorporate; a solicitor will be able to advise on the correct legal structure for you, while an accountant will be able to provide you with more details regarding the tax implications.