When you begin a business, choosing a business structure is one of the first decisions you will have to make. Which option should you opt for? Let us explain the main options (sole trader, partnership, limited company), the advantages of each, and then delve into the disadvantages.
Sole traders
When you run a business as a sole trader, you are self-employed and run the business as an individual (although you can employ staff). That means you have full control over how the business is run, and you can make all the decisions.
There are multiple advantages to operating your business as a sole trader. First, you might value that ability to make the decisions yourself as you have full control of the business. You will also keep all the business profits (once you have paid your taxes), as there are no business partners or shareholders entitled to a share of them.
Becoming a sole trader is more straightforward than the other options, as you only really need to register for self-assessment income tax with HMRC. Your business’s data is also private, unlike that of a company which has to share and publish certain data into the public sphere.
However, it can be difficult to attract external funding when you operate as a sole trader as investors tend to view these businesses as ‘risky’. You might also not like having all the pressure of the business being placed on your shoulders.
Being a sole trader can also be risky for you. That is because there is no legal distinction between the sole trader and the business, so you are entirely responsible and liable for any debts that it accrues. This is called unlimited liability.
Partnerships
A partnership is when at least two people form a business together. Partners share responsibility for the business and split the profits between themselves. They are then individually responsible for paying their share of tax (income tax).
Partnerships are very similar to sole proprietorships but with joint responsibility and decision-making. This allows you to delegate tasks based on each partner’s strengths, potentially reducing stress. Additionally, partnerships benefit from a broader range of perspectives and ideas, and having multiple partners can make it easier to secure funding for the business.
However, when there are many people in the business, disagreements are possible – if they become big enough, they could fracture the entire business. Partnerships, like sole traders, also face the risk that comes with unlimited liability.
Limited companies
A limited company, unlike a sole trader or partnership, is an organisation that is legally separate from the people who run it. You would therefore keep your business finances separate from your personal finances. Companies pay corporation tax, and most company owners pay themselves in dividends.
A limited company is an organisation that is set up to run a business. Unlike a sole trader/partnership, all of your business finances are kept separate from your personal finances. After payment of corporation tax, the profits are available to distribute to shareholders as dividends.
There are two types of limited companies:
- Public limited company (PLC): Shares can be bought and sold through a stock exchange.
- Private limited company (Ltd): Shares cannot be bought and sold through a stock exchange.
Running a company can be a great option for business owners because of limited liability – you and the company are legally separate, so you will only be liable for debts up to the value of your shares. It is also easier to attract investors, as they can buy company shares, although this involves you giving up some power.
You also pay corporation tax on profits, which is generally lower than income tax. The arrangement especially suits companies that earn high profits, as the highest rate companies will pay is 25%, while sole traders may have to pay 45% on some of their income. Company owners do have to pay themselves after the company pays tax, which means that their salary will face income tax. However, they can pay themselves in dividends, which are taxed less harshly than regular tax.
Just know that bookkeeping and accounting in a limited company is more complex because you are legally required to keep accurate financial records and submit them to Companies House.
Choosing a business structure depends on many factors. But no matter which you choose, running a business is tough. Contact us for friendly business, accounting, and tax advice.