What is the best corporate/legal structure for my business?
This is always a frequently asked question when planning a business start-up and is a key issue. The structure adopted will depend on a range of matters including tax aspects, legal liability, corporate governance and accessing profits.
Each legal structure has numerous advantages/disadvantages and the ramifications of each must be considered. Below is a short-form overview of each structure.
In many ways this is the simplest legal structure and is still widely used for individuals. All income and expenditure is simply included on your Personal Tax Return.
This remains a low cost and simple option for start-up businesses. Any losses are offset against the income and therefore can be effective from a tax point of view. In addition decisions can be made quickly with a minimum of delay/administrative steps.
The huge disadvantage is that you are personally liable for the liabilities of the business. Obviously if the business does encounter financial difficulties or is sued for a liability, your personal assets are very much at risk.
In general terms there are two types of partnership, (1) the general partnership; or (2) the limited liability partnership.
Partnerships are a common extension of the sole trader model, for example when two or more individuals work together to build the business. The partnership is just as flexible as the sole trader and has the merit of input from multiple individuals.
A Partnership Agreement is required as to how the liabilities, ownership and profits of the business are split and what happens if one partner exits. In a standard partnership, as with sole traders, all partners are also responsible for those debts owed by the business. This doesn’t only apply to debts you have incurred as a partner but to those of any other partner – particular care should therefore be taken of reviewing the conduct of your co-partners.
This remains a relatively simple and inexpensive way to form a business. There are also some tax advantages to including your share profits on a personal Tax Return. In terms of disadvantages, under an old style partnership, the partners can be personally at risk to creditors very much in the way of a sole trader.
Limited Liability Partnership
LLPs remain the UK’s newest business entity. Often seen as a hybrid structure, they offer the limited liability available to company shareholders combined with the tax regime and flexibility available to partnerships. At least 2 partners have to be ‘designated members’ responsible for filing annual accounts.
Just as with a limited company the LLP protects its members’ assets, limiting their liability to however much they have invested in the business/any personal guarantees they may have given when raising finance.
Tax-wise, the members’ share of profit is taxed as income – each member has to register with HMRC as self-employed. LLPs also have to register at Companies House and there should be a Members’ Agreement regarding profit share and corporate governance issues.
LLPs proliferated in the early noughties, particularly with accountancy and law practices in the UK.
A company is an independent legal entity separate from it’s owners which of course provides it with protection from personal liability should the company be sued. There are few exceptions to this concept of limited liability. Accordingly the individuals take shares in the company and report to a board of directors in terms of decision making. Limited companies pay corporation tax on their profits and the company directors are taxed as employees.
A huge advantage is the limited liability and the fact that the debts of the corporation remain with the company rather than personally binding the owners.
In terms of the demerits, there can be tax consequences in drawing monies out of a company, especially given dividend rates and there is certainly an administrative burden in terms of filings to HMRC and Companies House. Limited companies are often appropriate for more advanced start-ups and larger SME/companies which are co-owned by several individuals.
Detailed advice should always be taken with regard to choosing the optimum legal structure. Primarily, entrepreneurs are often driven by tax advice which is of course linked to the level of profits that are anticipated.
In general terms, a limited company is often the best vehicle for protecting key assets, given the flexibility of a company and credibility in raising capital as well as providing the best method of succession planning. A robust Shareholders Agreement and Articles of Association for a limited company can address a number of key issues and ensure that you have the right corporate governance rules as well as planning for a shareholder exit. The flexibility/transparency of a corporate structure is often attractive for any prospective purchaser, internal management team or a mixture of both.