Starting off with the right business structure can mean the difference between a successful and unsuccessful business. Here’s a brief overview to help you determine which is right for you.
Business Structures
There are various types of structures for a small business, all with benefits and drawbacks. Some of the most common are sole traders, partnerships, Limited Liability Partnerships, and limited companies.
Sole trader –If you’re the only one responsible for the business, you can choose to run it as a sole trader. It’s easy to set up as a sole trader, and you’ll have complete control over the business. You keep the profits of the business, after you’ve paid tax on them. However, there are some disadvantages, for example you’ll also be personally liable for any business debts. This means that if anything goes wrong, your personal assets could be at risk. Also, your profits will be taxed at your personal tax rate and this is often a lot higher than the tax rate paid by corporations.
Partnership –If you have one or more partners who are also responsible for the business, you can set up a partnership. The profits are shared between the partners, who pay tax on their portion. But just like a sole trader, the partners are liable for business debts.
Limited Liability Partnership – A Limited Liability Partnership (LLP) is an alternative business option that brings all of the benefits of limited liability, it also allows the flexibility when organising an internal structure. In an LLP, one partner is not responsible or liable for another partner’s misconduct or negligence.
Limited Company — A limited company is a corporation. When you set up a corporation you are creating an entity that is legally separate from your personal finances, which isn’t the case with sole traders and partnerships. This separation offers some key benefits, such as:
- Limited liability – as an owner, your personal assets will not be affected if the company were to get into financial trouble, except when you’ve signed a personal guarantee.
- Tax efficiency – Profits from corporations in the form of dividends are generally taxed at a lower personal tax rate than income earned as a sole trader.
- Deferred earnings – If your personal tax rate is high and you don’t need to draw dividends immediately, you can elect to leave profits in the business and take it out at a later date when your personal tax rate is lower.
- Ease of Funding – Because corporations have more demanding reporting requirements they frequently have better administration and record-keeping than sole traders and individuals. This gives lenders greater assurance that the business will be well managed and that loans will be repaid. Also, incorporated businesses can raise funds by equity financing, which involves selling shares in the corporation to investors in exchange for risk capital to help grow your business.
Extra responsibility
Although incorporated structures offer significant benefits, there are many extra responsibilities. These include:
- Directors must abide by the Companies Act 2006, and must exercise reasonable skill, care and diligence.
- Directors must also act in the interest of the company and not themselves.
- The company must maintain accurate financial records at all time.
- The company must submit annual accounts to Companies House.
- Your must submit a company annual corporation tax return to HMRC, and pay its liabilities before the deadline.
- You must ensure that the company can meet all of its outstanding financial liabilities, and trade solvently at all times.
- You are responsible for paying your staff, and deducting the correct amount of income tax and National Insurance Contributions from your employees.
- If your company has annual turnover greater than £85,000, it must register for VAT. You will then add VAT to your sales invoices, calculate the amount of VAT payable to HMRC and make regular filings to HMRC of all your VAT data. You will also then be able to claim back all the VAT you spend on qualifying expenses and overheads, increasing your profits.
Make the right move today
Please note that the form of business ownership isn’t fixed forever and you can change the legal structure of your business as it grows. A common scenario is for small businesses to start out as sole proprietorships or partnerships and become incorporated at some later date when the business has grown.
Contact Us for advice on which legal structure is best for you and your business. This will depend on your own personal circumstances, your level of resources and also your plans and objectives. Getting the structure right is important and you could help you pay a lot less tax on your business profits