Mrs Hilton adapted from: www. Lawpack.co.uk
Starting a new business - Choosing the
right business legal structure
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When you start your own business there are a lot of decisions you need
to make. But before you jump in, the first thing you need to do is choose
the right legal structure for your business start up.
Choosing the right business legal structure is vital as it can affect the
amount of financial risk you're taking on, the amount of tax you have to
pay, the control you have over your new business, and the
administration you'll need to do.
But do you form a limited company? Form a business partnership?
Or act as a sole trader?
Here’s a brief guide to the different business legal structures you can
choose for your business start up:
Business legal structure #1: Sole trader
Operating as a sole trader is the simplest form of business legal
structure.
As a sole trader you are in charge of all aspects of your business start
up. You’re personally liable for all debts of the business, even in excess
of the amount invested. You and the business are considered the same
entity.
Pros of a sole trader:
It's a very simple business legal structure to set up and operate.
You are in complete control of the business and all the profits go to
you.
There may be tax advantages.
Cons of a sole trader:
Lack of support.
Unlimited liability - you're personally liable for any debts run up by
your business start up.
Mrs Hilton adapted from: www. Lawpack.co.uk
Potential difficulty in raising capital because you cannot transfer an
interest in the business to investors as security for their
investment.
Business legal structure #2: Business partnership
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A business partnership involves two or more individuals carrying on a
business together with a view to profit. Each business partner is
personally liable for all debts of the partnership, including those incurred
by the other partners.
So, when you’re forming a business partnership, it’s important to draw
up a Business Partnership Agreement. A business partnership
agreement gives a proper foundation to the business relationship and it
outlines how any problems will be resolved, should the business get into
trouble.
A business partnership agreement is also part of the evidence that you
must give to HM Revenue & Customs to prove that the business
partnership is in existence.
Pros of a business partnership:
It's a very simple business legal structure to set up and operate.
Your business partners can bring a range of skills and experience
to the business start up, and there is a broader management base
than a sole trader.
You may pay less tax, by avoiding double taxation, for example.
This is where the company pays corporation tax on its profit, but
later the shareholders effectively pay tax on the same profits
through capital gains tax on their shares sale and income tax on
their dividends.
Cons of a business partnership:
Problems can occur between business partners.
There is unlimited liability for all the partners. You’re all personally
liable for the debts run up by the business partnership.
Obtaining large sums of capital is relatively difficult as investment
cannot be obtained from new shareholders.
Business decisions taken by just one partner bind all the partners.
The business partnership may come to an end when existing
partners leave or die.
Mrs Hilton adapted from: www. Lawpack.co.uk
It may not be easy to sell or transfer an individual business
partnership interest.
Some tax incentives, such as employee share option schemes, are
not available to business partnerships.
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Business legal structure #3: Limited liability partnership (LLP)
The business legal structure of a limited liability partnership (LLP) is
similar to an ordinary business partnership in that a number of
individuals or limited companies share in the risks, costs, responsibilities
and profits of the business.
But with a LLP the liability is limited to the amount of money the
business partners have invested in the business and to any personal
guarantees they have given to raise finance. This means that business
partners have some protection if the business runs into trouble.
Pros of a limited liability partnership:
LLPs retain the flexibility of a business partnership.
With an LLP, your personal liability is limited.
Cons of a limited liability partnership:
LLP formation is more complex and costly than that of a business
partnership.
Problems can occur when there are disagreements between the
business partners.
Just like a business partnership, it’s important when forming a LLP to
draw up a Limited Liability Partnership Agreement.
Business legal structure #4: Limited company
The benefits of forming a limited company are limited liability and raising
capital easily. But the advantages of this business legal structure may
not outweigh the disadvantages of higher costs, increased paperwork
and greater regulation to which you will be subjected once you form a
limited company.
Pros of limited company formation:
Limited liability. The shareholders are not personally liable for the
debts of the limited company. The limited company can only ask
Mrs Hilton adapted from: www. Lawpack.co.uk
shareholders to pay for their shares in full, if they haven’t already
done so. The shareholder’s responsibility is limited to this amount
and this amount is determined when the shareholder agrees to buy
shares. Should your business start up fail, the creditors cannot
obtain possession of shareholders’ assets in settlement of debts.
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But the directors may find themselves liable to pay the limited
company’s debts.
Capital can be raised with relative ease because investors can buy
shares in the limited company. But this doesn’t mean that a new
company can simply offer shares to the general public. Share
offers are regulated by law.
Subject to the Articles of Association, shares can be transferred
to existing members and to family members as gifts or otherwise.
It’s possible to sell your shares in the limited company to other
people, but not in a general offer to the public.
Since the limited company is an independent legal entity, it doesn’t
cease to exist because one of the shareholders dies or retires. So
it’s easier to ensure the continuity of a limited company than of a
business partnership.
Cons of limited company formation:
The limited company must comply with statutory rules and disclose
information to the public.
A limited company is usually the most expensive form of business
to organise and run, although a business partnership can be
equally expensive, especially a LLP.
Both the limited company and the individual shareholders have to
make tax returns.
Record keeping (such as keeping a minute book) can be more
extensive for a limited company.
Winding up a limited company and, in many cases, even changing
the business legal structure can be more complicated and
expensive than for business partnerships and sole traders
TASK: Now create a diagram / comparison chart to show the
differences, and also the pros and cons. An at a glance guide for a
new business