| 09 August 2019
What “type” of business to start?
Written by Luke Faulkner
You’ve got your business idea, you know what you want to do, but how or what “type” of business set -up are you planning to start and operate.
For any business to be robust and sustainable it will need to generate money. Can you make more than you spend? If not, you simply won’t stay in business. Selecting what “type” of business to start is an important first step, getting it wrong now could expose you to unnecessary risks and costs in the future.
The main options are a sole trader, limited company, partnership, limited liability partnership or Social Enterprise/Community Interest Company. If you decide to start a business with other people, it would make sense to agree and address practical issues such as money invested, roles, responsibilities to avoid potential problems in the future.
Let’s look at each in a bit more detail
The easiest way to start your business.
The owner-manager of a small business can operate as a sole trader and be up and running immediately!
- You must register with HMRC within three months of starting up.
- The administrative burden is far lower than for a limited company. You keep simple, unaudited accounts recording your business income and outgoings.
- Despite the name, a sole trader can still employ people.
- As you grow, you can decide to form a limited company and transfer the business to it - although some stamp duty may be due.
The biggest disadvantage is your personal risk
- You are personally liable for all your business debts. This means that your own assets - including your home - are at risk. If you cannot pay your business debts, you can be made bankrupt and lose your personal possessions.
- Your options for raising money are limited.
- Succession planning is tricky - it is generally harder to sell the business or pass it on.
Sole traders are generally taxed as self-employed
- Income tax is payable on any profits, not on the amount taken from the business.
- National Insurance contributions are usually lower as a sole trader than as an employee of a company. However, you are entitled to fewer social security benefits too.
- Your Accountant or financial adviser are best placed to offer you advice as to whether your overall tax and National Insurance liability is likely to be lower if you are a sole trader (or partnership) or a limited company.
The easiest way in which to protect your personal assets.
Setting up a limited company can reduce the risk of personal financial loss
- Personal risk is generally limited to how much you invest in the business and any personal guarantees given to obtain finance for the business such as bank loans, credit cards etc.
- If the business fails owing money, any creditors are paid with any money left from the sale of the company's assets.
- Under normal circumstances, creditors have no legal right to obtain repayment from the directors or shareholders of the business (unless they have offered personal guarantees).
- Directors can be held personally liable in some circumstances, e.g. if they have allowed the company to trade fraudulently, insolvent or have been deliberately negligent.
The advantages for having a limited company may increase, as your business grows
- A limited company has more credibility, this may be important to your clients.
- It is easier to raise finance for the business or sell a part of the business.
- You can generate and reward loyalty within your Key workforce, by offering them a stake in the business.
- There are considerable tax advantages for high earners by investing in the business or contributing to a pension.
However, registering as a Limited Company does generate some significant administrative costs and additional obligations, which included:
- You must submit annual accounts and tax returns to HM Revenue and Customs (HMRC) within their deadlines or risk a fine if they are late, or incorrect. Annual accounts are generally more complicated than self-employed and would generally require the services of an Accountant.
- If your turnover is in excess of £10.2 million, an independent audit is compulsory and will incur additional costs.
- Confirmation statement and annual accounts need to be submitted to Companies House, and the company's finances will be publicly available.
- There are other statutory requirements. For example, you must let Companies House know about any change of directors and submit information accurately and on time to avoid fines and penalties.
- You will need to set up a payroll and register as an employer with HMRC.
- If you cease trading, there is a process you need to follow, and it can be more difficult and expensive to wind up the business.
The company pays corporation tax on any profits and you are taxed as an employee
- Company directors pay income tax on salaries and benefits through PAYE like other employees.
- National Insurance payments can be higher than for a sole trader or partnership. You must pay employer's as well as employees' National Insurance contributions on salaries, including those of directors.
- As a shareholder in a limited company, you may be able to take dividends without any National Insurance contributions being payable, making it more tax efficient.
Where two or more people set up a business together.
A partnership allows you to share profits, management responsibilities and risks.
- As a member of a partnership you are personally and jointly liable for any debts incurred. If another partner is unable to pay, you become liable for their share of the business debts.
- Your personal possessions can be at risk if you fail to pay your debts.
- You may be able to raise money by introducing new partners. A 'sleeping partner' is one whose involvement extends only to contributing capital and sharing in the profits.
- Business contracts entered by one partner can be binding even if other partners have not been consulted or given their consent.
You can set up most partnerships with a few formalities
- The partnership must be registered with HMRC. Each partner must also register as self-employed.
- To avoid costly disputes, it is vital to discuss the roles, responsibilities of each partner and have a comprehensive Partnership Agreement in place and agreed by all partners. A good FREE resource to view generic templates is www.lawdonut.co.uk
Members of a partnership are generally taxed as self-employed
- Income tax is payable on each partner's share of any profits.
Limited Liability Partnership
A corporate body with its own legal identity and capacity.
- An LLP has the organisational flexibility of a traditional partnership. Members share management responsibilities and you may be able to introduce new members to raise money.
- Each member's liability is limited to any personal guarantees they have made to secure finance and any money they have personally invested.
- Any withdrawals of capital from the business can be clawed back if the partnership is declared insolvent within two years of the withdrawal.
Forming an LLP is more complicated than setting up a partnership and we would recommend you access specific advice from an accountant or a solicitor.
- You must register with Companies House or use an agent to do this for you.
- Self-employed members of an LLP must register as self-employed with HMRC within three months of starting up.
- It is important to have a suitable and confidential members' agreement drawn up.
You must comply with a range of administrative requirements
- These are like those faced by limited companies.
Members of an LLP are generally taxed as self-employed
- Income tax is payable on each partner's share of any profits.
A business model not a legal structure, that puts the interests of people and the planet before shareholder gain. It is estimated there are over 70,000 social enterprises in the UK.
You must choose a business structure even if you’re starting a business with the aim of helping people or communities (a ‘social enterprise’).
Social Enterprise UK states that Social Enterprises have five characteristics:
- A social mission – this will be written in the company and embedded as part of the culture
- Make 50% of revenue from trading – either selling products or services
- Reinvest or donate 50% of their profits – this reinvestment or donation will be put towards a cause that is aligned with the social mission
- Independently owned – owned and controlled in the interests of the social mission
- Transparent – in everything that they do and how they report their social impact and how they operate
If you want to set up a business that has social, charitable or community-based objectives, there are several options you can consider:
- limited company
- charity, or from 2013, a charitable incorporated organisation (CIO)
- community interest company (CIC)
- sole trader or business partnership
If you’re setting up a small organisation like a sports club or a voluntary group and do not plan to make a profit, you can form an ‘unincorporated association’ instead of starting a business.
If you are interested in starting up a social enterprise then Social Enterprise UK and UnLtd are great resources for when you start your journey.
Community Interest Company - CIC
A CIC is a special type of limited company which exists to benefit the community rather than private shareholders.
It was introduced by the UK government in 2005 with the intention to be easy to set up, much like a company, but with special features to ensure that they will work for the benefit of the community.
A Community Interest Company cannot be a charity!
To set up a CIC, you’ll need:
- a ‘community interest statement’, which clearly explains what your business plans to do
- an ‘asset lock’- a legal promise stating that the company’s assets will only be used for its social objectives, and setting limits to the money it can pay to shareholders
- a constitution - you can use the CIC regulator’s model constitutions template
- to get your company approved by the community interest company regulator - your application will automatically be sent to them
The CIC regulator has guidance on setting up a CIC.