In this article, we examine the different trading structures used by small businesses—sole trader, limited company, partnership, and LLP—and highlight the pros and cons of each one.
Sole Trader
The simplest, most hassle-free way to start a business is as a sole trader (otherwise known as being ‘self-employed’).
You need to inform HMRC of your intentions to become self employed (or soon after you have started), and will have to complete a self assessment tax return each year.
You pay income tax and Class 2 / 4 National Insurance Contributions on any profits your business makes.
Unlike the limited company structure, sole traders do not have the luxury of limited liability if something goes wrong – any business debts you incur, for example, will be counted as personal debts.
Pros
Easy and inexpensive to set up. You can start trading right away.
Minimal administrative requirements.
Complete control over business decisions and profits.
Cons
Unlimited personal liability for business debts if things go wrong.
Limited ability to raise capital.
It may be perceived as less professional compared to a limited company.
Partnership
Two or more self employed may decide to work together and set up a partnership.
As with sole traders, partnerships do not enjoy the benefit of limited liability.
The partners will share in all aspects of the business – in terms of the partnership’s profits and liabilities – which are shared.
You should sign a partnership agreement if you decide to go down this route.
The partnership agreement should cover important issues such as how the business will be run, how the profits will be split, and what happens if a dispute arises between partners.
Pros
Easy to set up. The partnership can start trading straight away.
Flexibility in management and decision-making.
Combined expertise and resources of partners.
Cons
Unlimited liability for all partners if things go wrong.
Potential for conflicts between partners if disagreements arise.
Profit sharing may not always align with individual contributions.
Unlike the sole trader structure, a limited company is a distinct legal entity from its directors and shareholders.
Shareholders are only liable for the amount of money they have invested in the shares.
Company directors have limited liability, although if you provide personal guarantees to secure business finance, you will have some personal liabilities.
Limited company directors have several legal and financial obligations to meet, including dealing with Companies House – the registrar of companies in the UK.
Your company will be liable to pay Corporation Tax on any profits. The directors must complete an annual self-assessment return for the income you draw down from your company.
A limited company may provide a more professional image for your business, and in some cases (such as IT contracting or Interim Management), you may not be able to operate as a sole trader.
The costs of incorporation are not high; you can set up a limited company for under £50 these days, but operating as a limited company is a little more expensive than being a sole trader (mainly due to higher accounting fees).
Pros
Limited liability protects the personal assets of directors.
Potentially provides a more professional image.
Possible tax advantages and opportunities for raising capital.
Cons
Forming and running a company is more complex and costly than being a sole trader.
Ongoing administrative responsibilities and regulatory compliance (e.g. Companies House).
The LLP is a distinct legal entity, like a limited company, and is governed by Companies House.
To form an LLP, there must be at least two members, who can be individuals or businesses.
You should draft a Deed of Partnership to outline how the LLP is to be run and detail the roles and responsibilities of its members.
The LLP model is relatively flexible, and members are taxed directly via self-assessment.
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Many accountancy and legal firms use the LLP structure, although small businesses or start-ups do not widely use it.
Pros
Limited liability protects the personal assets of members.
Flexibility in management and distribution of profits.
Attractive to professional services firms such as accountancy and legal practices.
Cons
Setting up and managing an LLP is more complex than the standard partnership.
It is less common among ‘standard’ small businesses and start-ups.
Requires careful planning and drafting of partnership agreements.
Further information and resources on business structures
Unsurprisingly, no strict rules determine which business structure you should choose for your start-up.
We highly recommend you discuss your options and get professional advice from an accountant before deciding which business structure to use for your enterprise.
