You want to start a business but you are not sure what the right business structure for you is. Do you want to be a sole trader or do you have a partner to share the hurdles of running a business? And if you do have a partner do you incorporate or do you simply start working together? Choosing the right medium to run your business is crucial as each business structure is different and has its own advantages and disadvantages. Choosing right can make the difference between success and failure.
As a sole trader you are self-employed, you are your business. You are responsible for everything that’s going on as the business doesn’t have a legal entity. You alone benefit from its gains after you have paid tax on them but you are also solely responsible for its losses.
It is very easy to start trading as a sole trader; there are no documents required, you don’t have to register with the Companies House and if your takings are low enough (below £82,000) you don’t even have to register for VAT. For tax purposes you need to register with HMRC to do a self-assessment tax return every year and that’s about it. You can start trading immediately.
On the other hand, you may have a business partner and want to share the responsibilities and the gains of setting up a business. But how do you do it? Do you just start trading together or do you incorporate?
The traditional partnership of the Partnership Act 1890 doesn’t need any formality to come into existence. Its existence is a matter of fact as it can be established orally, by a course of conduct or by an agreement. The partners have unlimited liability for the debts and obligations of the business.
No partnership agreement is necessary and in the absence of one the Partnership Act 1890 and case law provide fall-back provisions. However, it is always better to draw a Partnership Agreement to tailor the business to your particular needs and avoid any conflicts in the future as relationships can break down. A well drafted Partnership Agreement can set out provisions regarding the sharing of profits and losses, and on dissolution, the capital. It will also provide for how new partners can join and how old ones can retire and how a partnership can be terminated.
A different type of partnership is the Limited Partnership (LP) that requires at least one general partner and one limited partner. The general partner has unlimited liability, while the limited partner has limited liability up to the amount of his/her contribution. Therefore, limited partners are not involved in the day-to-day management of the business. If they do get involved they become liable for all the debts and liabilities incurred by the partnership during that period.
Even though LPs do not have a legal entity they must be registered at Companies House. Failure to do so will result the partnership being treated as a traditional partnership where all partners are liable. Limited partners must agree before any changes are made to matters such as profit shares, expulsion of a partner, the nature of the business and variation in the partnership agreement. LPs are usually used for private equity fundraising, venture capital funds and real estate investment vehicles.
Limited Liability Partnership
The newest type of partnership is the Limited Liability Partnership (LLP), a hybrid business vehicle that has features of a company and of a limited partnership as well. An LLP has its own legal entity which means it can enter into contracts and is liable for its debts. On the other hand, for tax reasons, an LLP is treated like a traditional partnership and each partner will be taxed individually. Partners are liable to income and capital gains tax for their share on the income or gains of the business. However, the LLP will have to register on its own for VAT purposes.
An LLP must be registered at Companies House by providing an incorporation document and obtaining a certificate of incorporation. It must also file to the Companies House the accounts and annual return. The Companies House must also be informed of any change regarding the name of the LLP, its registered office, members etc.
A Membership Agreement between the partners or between the LLP and the partners is not a legal requirement for the formation of an LLP. However a Membership Agreement can be very useful as it will set out mutual rights and duties and provide amicable ways of solving disputes. If no agreement exists the default provisions set out in Limited Liability Partnership Regulations 2001 will apply but having a tailored Membership Agreement that will cater for the specific needs of the business and its members is always better.
The most complex business structure is that of a limited company. This can be a limited company by shares or by guarantee or a public limited company. A limited company has its own entity, it can enter into contracts in its own name, and it has assets. A limited company is liable for its debts and liabilities. It has shareholders and directors. Shareholders are the members of the company and they are personally responsible for its debts only for the amount of unpaid shares they own or for the amount of their guarantee. The Directors are responsible for the management of the company but are not personally liable for the company’s debts unless they have broken the law.
There are strict formalities that have to be followed to set up a limited company. It must have Articles of Association, be registered with the Companies House and follow the provisions of the Companies Act 2006 that provide for its formation, registration and how it must be run. Getting legal advice before setting up a limited company is important.
At CH Legal our team can give you detailed advice and help you decide the right business vehicle for you. Niki is a member of CH Legal’s Commercial Team and can be contacted by email at email@example.com or by telephone on 0161 745 9170