To be or not to be (a limited company)

The term “business vehicle” doesn’t just refer to a company car: it also references the type of legal structure you use to trade under. Your choice will have profound implications.

Why does it matter?

Your choice of business vehicle will directly affect the way you run your business. It will impact the cost of running it as well as the tax you pay and the amount of personal liability you incur. The ease with which you can accommodate future investors and business partners and the structure of your staff compensation packages will be affected, as will how you own property and manage your pension. It even has an impact on how you can exit your business when that time comes.

The main commercial business vehicles are:

Being self-employed (aka ‘sole-trader’ and ‘sole proprietor’)

This is just you, trading under your own name (you can use a business name, e.g. “The Sussex Bagel Bakery”, but it’s still you – the name is just a trademark/brand). The advantages are that you can begin immediately; you don’t have to register with anyone; it’s free to start; it’s flexible (you are the boss and, as long as you obey the law and pay your taxes, then you get to call the shots). There is nothing stopping you hiring staff; renting business premises; getting registered for VAT; etc. Nor do you have to worry about statutory obligations to do things like file an annual return (nowadays called a Confirmation Statement) or prepare accounts (although in practice you may need them to manage the business and work out if you owe HMRC).

The drawbacks tend to arise when your business becomes profitable or overly complex. Profit is subject to income tax and national insurance, which can save you money if you are in the lowest tax bands but can be quite painful if not.  By definition, a sole trader is a one-person business. If you need co-owners/partners to run the business, you can’t be a sole trader. Along with tax, perhaps the biggest drawback is the personal liability. If something goes wrong in the business, then because the business is you, it is you who are personally liable – and so your personal assets (e.g., your family house) may be seized to pay business debts. For these reasons, most sole traders run smaller, simpler, businesses.

Not surprisingly sole proprietorships are the most popular form of business vehicle: circa 3.5 million in a recent count (i.e., about 59% of all UK businesses).

Partnerships

There were 414,000 partnerships in 2019, equal to circa 7% of all UK businesses. Partnerships can be incorporated or unincorporated. Unincorporated partnerships are akin to being self-employed – except you’re trading together with somebody else as a co-owner. A difficulty with unincorporated partnerships is they automatically come into existence when you start acting in concert with another person(s) for the purposes of conducting business. Lots of people have unincorporated partnerships but don’t necessarily realise it – and because they don’t realise, they have not agreed all the terms of a partnership. This makes things very messy if partners subsequently fall out as there are issues about ownership of assets (including any business name, customers, goodwill etc.). Each partner can legally bind/be held responsible for the actions of all the other partners and issues can arise regarding responsibility for any losses.

The advantages of unincorporated partnerships are like those of a sole trader – immediate; free to establish; privacy (there is no public record), etc.

Incorporated partnerships are a blending of limited companies and unincorporated partnerships. As far as the world is concerned, they are dealing with a limited company, but internally the governance and reward mechanisms (and tax liability) are structured like a partnership. The main draw of an incorporated partnership is the much-reduced personal liability: unless it’s something particularly outrageous if the LLP messes up, then it’s the LLP and its assets that are held liable, not the individual partners and their personal assets. Incorporated partnerships have similar obligations to limited companies, e.g., to register on incorporation and file various documents at Companies House. Incorporated partnerships are much more public than unincorporated ones, e.g. they have to have accounts drawn up and be available for public viewing at Companies House.

Limited Companies

Often referred to as private limited companies (to distinguish them from PLC’s), there were 2 million in 2019 (circa 34% of UK businesses).

Limited companies are treated as separate legal entities from the shareholders who own them and the directors who manage them. That’s why directors and shareholders can be found to have defrauded their own companies.

There are many advantages of trading through a limited company:

• You can easily separate investors and owners from managers (e.g. allowing for professional managers)

• It is easier to have different percentages of ownership.

• They are generally more tax efficient.

• It is easier to accommodate investors.

• Their ownership and governance structure works well for larger/more complicated businesses.

The main disadvantages are that they are subject to much more regulation and public scrutiny, and they can be expensive to set up and maintain as a result. It is often easier for original owners to be pushed aside against their will, and once you have finished with your company you need to actively close it.

Which vehicle is right for you will depend on your circumstances, especially regarding likely tax implications.

By James O’Connell, Partner

www.mayowynnebaxter.co.uk