Selecting the right legal structure

By Michele Gioia

You’ve decided to start your own business, a time filled with excitement. However, it can also be a daunting venture into the unknown. One of the first decisions to be made is which legal structure your business will take. This has wide-ranging implications, from tax, to how and by whom your business is controlled and who will have to pay any debts or liabilities owed by the business.

There are four main legal structures to consider. These are sole trader, partnership, company or limited liability partnership.

If you start trading in your own name or under a different ‘trading as’ name, it may be easiest to do so as a sole trader. While this is the most straightforward way to start trading, there is no legal distinction between your personal assets and those of your business. You are your business. So a business creditor can enforce a business debt against your personal assets, including your home.

A partnership is a commercial relationship between two or more persons who carry on business with the view to earning a profit. It is not a separate legal entity and the partners are still personally liable for the debts of the partnership.

The management of a partnership is usually set out in a partnership agreement. Partnership agreements cover matters including the nature of the partnership’s business, how it is managed, the distribution of any profits and what happens if and when partners change.

A company is a common form of business vehicle in the UK. Companies are formed by registering them with the Registrar of Companies at Companies House.  Companies must make a large amount of information public, including annual accounts, something which is not required of a partnership.

There are three types of companies. These are limited companies, unlimited companies and public companies.

Most companies are limited companies. These are limited by shares. In the event of a company being liquidated, the shareholders’ liability is limited to the amount paid for the shares.

In contrast, if an unlimited company goes into liquidation, the shareholders are liable to contribute all of their wealth – or as much as is necessary – to discharge the company’s debts.

While the majority of companies are private, a company can be a public company which is a prerequisite to list with the UK Listing Authority and trade on a stock exchange. As you can imagine, public companies are stringently regulated.

While most businesses involve the risk of capital, the biggest advantage a company has is that it can be formed with limited liability. If a partnership becomes insolvent then the partners are jointly and severally liable for all of the debts of the partnership.

There are more expenses to be incurred in operating a company as opposed to either a sole trader or partnership. There are fees for the incorporation of a company, for the registration of its articles and to have accounts prepared to be filed with the Companies House.

You do not have to choose between trading as a partnership or as a company, however. Limited liability partnerships (LLPs) allow entrepreneurs the flexibility of the partnership arrangement and afford them the protection of a company.

The LLP is a distinct legal entity from that of the partners. This means that the partners are not liable for the debts of the LLP. In practice, however, this is not clear-cut as partners can still be liable in certain instances.

When creating an LLP it must still be registered with the Registrar of Companies and the trade-off for limited liability is public disclosure, similar to that of a company.

While both the Companies Act and the Partnership Act prescribe certain rules for the management of a company and partnership, respectively, both types of business mediums can agree on a management structure, through the use of agreements.

A company can choose how to use its profits. For instance, it can use the profits to pay dividends or that can be retained in the business, with each choice having a having an effect on the company’s taxation of its profits. A partnership, on the other hand, offers less scope for tax planning as all of the income profits are taxed as income of the partners, whether they are actually paid to the partners or retained in the business.

Before making the decision how you will commence your business venture it is advisable to give the above considerations some thought and get advice from your legal and financial advisers to ensure you are properly structured for growth.

Michele Gioia is a senior solicitor within the dispute resolution department at City of London law firm Carter Lemon Camerons LLP.
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