Deciding on the most appropriate legal structure for your start up business is a critical step, as it could impact the degree of financial risk you are exposed to, the control you maintain over your business and the level of expected daily administration activities.
Having made your decision to start a business, you must look into some legal requirements for the start up, such as the kind of ownership you are looking for, the name / title of the business organization and your relationship with your partners.
The Legal Form to Be Adopted
The following are the main choices you can consider for the legal form that can be adopted for your business.
- If you are the sole proprietor of your business, you are self-employed and have no legal structure to adhere to.
- In the case of a partnership, two or more business partners will work with you and will share the profits and losses equally.
- There is also a limited company type, in which the business is a separate legal entity. In this, the business is distinct from its directors, shareholders and employees. Unlike the other two, in this type the business can sue or be sued separately from its owners.
- A limited partnership liability could be said to be a mixture of a partnership and a limited company. In this type, the partners have a limited liability and the business can run even with the resignation or death of its partners.
These days, other forms of business such as Co-operative Societies and Company Interest Societies have also become quite widespread. However, once you have adapted a certain legal form, it is still possible to change it although it will require a lot of investment in terms of time and finance. If your business has re-registered with VAT, you must inform your local VAT office within a 30 day time period. The other legal requirement for the change can be checked with your legal and accounting departments.
Sole Proprietorship
A sole proprietorship is when the business is owned and managed by a single person. Many new start-ups prefer to have a sole proprietorship as it comes across as the best and most feasible option.
The advantages of a sole proprietorship are as follows:
- Setting up the business is very simple and can be quickly done by just registering your business with the VAT, tax and other concerned authorities.
- Your gross tax payments will be lower compared to other forms of business; this is, of course, if your earnings are not very high.
- Your National Insurance will be low.
- You can maintain simple, unaudited accounts.
Later on, you can also form a limited company and merge your business with it by paying some stamp duty.
The disadvantages of a sole proprietorship are:
- As a sole proprietor, your financial options are quite limited and you are entitled to fewer social security benefits.
- Your assets are at a high risk, as you are personally responsible for all your debts.
- Also, it will be difficult to sell or pass on your business to others.
Partnership
A partnership form of business shares the same advantages and disadvantages as a sole proprietorship. However there are a few other aspects as well:
While forming a partnership, you must first have an agreement drawn by a lawyer and agreed upon by all partners in order to avoid future disputes.
In a partnership, each member is liable for the losses or debts suffered, even if caused by other members.
There is more scope in a partnership to raise money as all the other partners could contribute financially as well.
Limited Company
The advantages of a limited company have a propensity to increase as your business develops. The following are the advantages:
- In the case of a limited company, the liability of the members is restricted to the amount they have invested in the company by buying the shares. Personal liabilities may arise in rare circumstances of company fraud or security on company borrowing etc.
- In terms of financial stability, it is easier to raise money or to sell the business when need arises since a limited company enjoys more credibility.
- High earners can enjoy tax advantages by keeping their money in the business or pension payments.
The few disadvantages are:
- Annual accounts are usually more complicated. Also a high turnover requires for regular audits. If your turnover climbs above £ 5.6 million, an independent audit is compulsory, costing you at least £ 2,000.
- There are greater costs and obligations involved. Ceasing the business is a lengthy and expensive procedure.
- The National Insurance payments are higher as you have to pay the directors', employers' and employees' National Insurance contribution on salaries.
A limited company must be registered at Companies House and so setting up a limited company involves some red tape. Here you can adapt one of these methods:
You can ask your solicitor or accountant to buy you an off-the-shelf company and to provide advice on all the details (costs will be from £ 200 upwards).
You could use a reputable company registration agent (cost will be around £ 60 - £ 200).
You can also undertake the registration process yourself after seeking professional advice and guidance.
Like the partnership agreement, in a limited company, a shareholders agreement helps all the people involved in a business considering their credibility and share in the business. The agreement covers the key issues concerning the business and possible 'what if' scenarios, such as:
How much money the members will contribute in the initial investment and for what amount of reward in return?
If need be, how will you raise money for the capital in the future?
If in the future a member needs to take out extra money, how will that situation be deal with?
How will the dividends and salaries be distributed to the directors and shareholders?
Who will take all these crucial decisions?
How fast will the business expand and who is responsible for each business area?
If the company disbands, will the members buy each other out or will the company be sold?
Having a sound shareholders agreement before starting a limited company is essential as it minimizes the risks and gives the members a clear idea of what rewards to expect in terms of financial investment.
Limited Liability Partnerships
Despite the name, a limited liability partnership is not a partnership per se. It has the following features:
It is a corporate body with its own legal identity and faculty; different from partnership in its organizational flexibility.
Tax is charged for all profits, distributed or undistributed.
Members can limit their liability in case of losses.
Annual accounts must be prepared and filed in strict compliance with filing requirements and time limits.
There must be a confidential members' agreement which should be accepted by all.
A limited liability partnership must be registered at a Companies House. Your accountant or solicitor can help you with the registration details.
If the limited liability partnership is declared insolvent within two years, then the withdrawals may be clawed back.
Tips
- Keep your company name short and simple if you're a consumer-facing company.
- Your company name should give you the freedom to expand into other activities.
- Aim to secure the domain name for your trading name early on, irrespective if you are planning to sell over the internet or not. Your customers would rather be reassured to see a professional presence online, particularly if they are checking out your business.
- Take professional advice on the best way to set up your business - do not assume that you need to form a company.
- Before going into any partnership, reflect on the likely business relationship and how it is going to work in practice
- As circumstances change, consider if your business structure is still the right one for you. You do not have to stick with the structure you chose when you started up.
The full version of the "How to form a business" ebook, available from most book stores, helps you learn how to:
- Choose the right business legal form
- Maintain working relationships
- Select a name for your business