Business Structures: Choosing the Appropriate Formation

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When setting up a business, there are key decisions you have to make. Some of these decisions have a lasting effect on your business, the path it will take, and how it will be treated by the authorities. The legal structure you choose when forming your business is one of these.

Taxes levied, the liability you shoulder as the business owner, and the amount of paperwork you will be required to do differ based on the structure of your business. As a matter of fact, the ability to raise seed capital or operation finances is also impacted by the legal form.

Common Business Structures

There are many different types of structures out there, some more popular than others. For instance, you may come across franchises, co-operatives, common interest companies, and offshore companies.

However, the following are the commonly chosen business structures in most jurisdictions including the United Kingdom:

  • Sole trader
  • Partnership
  • Limited company
  • Limited liability partnership

Sole Trader

Sole traders run their businesses as self-employed individuals. This is the structure startups with limited financial resources prefer. Operating as a sole trader doesn’t necessarily mean that you work alone in your business, you can employ staff. Below are some of the benefits:

  • Easy to set up – Legal costs are lower and set up regulations minimal
  • Decision making and control – Sole traders have absolute power over the conduct of their business affairs. Their decisions are first and final.
  • Tax benefits – The sole trader and the business are treated as one and the same person for tax purposes. Business and the owner’s income are merged and treated as a personal tax return.

When you choose this business formation, it is important to acknowledge the inherent drawbacks.

  • Unlimited liability – Business debts and other liabilities can be recovered from the personal wealth of the sole trader. No distinction exists in law between the business and the owner.
  • Lack of business continuity – In the event the owner retires, dies, or is incapacitated, the business also comes to a stop.
  • Difficult in raising capital – The business cannot issue stock or pursue aggressive capital raising ventures, unlike corporations.

Partnership

This structure is appropriate if you are two or more individuals that want to partner in setting up and managing a business. It is more or less an extension of the sole trader model, but with the benefit of having more than one head in decision making. This improves the quality of decisions taken.

You agree on how to share management responsibilities, compensation for duties undertaken, and the profit sharing ratios. To have a successful partnership, you need legal provisions in the form of a partnership agreement or deed in place to cater for situations such as:

  • The admission of a new partner
  • Retiring, dismissal, or death of a partner
  • The dissolution of the business

You can decide to have a standard partnership where partners are personally liable for business obligations including debts. This form is known as unlimited liability partnership. With respect to tax, the income received at the partnership level is distributed according to the prior agreed profit and loss sharing ratios.

A Limited Liability Company

As the name suggests, this business structure gives the owners or directors limited liability with respect to the company operations. There is a layer of protection from confiscation and appropriation of personal resources arising from business liabilities. This is because the business is a separate legal entity capable of suing and be sued. Other advantages include:

  • Credibility – Before the eyes of lenders, limited liability companies are considered more professional and reliable. This makes it relatively easier to access funding.
  • Business Formation – The legal and financial hurdles in setting up this kind of business although rigorous, have improved with time and some of the red tape cutoff.
  • Tax Advantage – When it comes to taxes, limited liability companies pay corporation tax on their realized profits. The owners or directors are normally taxed the same way as employees.

The drawback to this legal form of business is the double taxation where income is taxed at the company level and still taxed at the director’s level as personal income. Also, the statutory requirements to submit accounts and do annual returns can be taxing.

The first step in forming this business is to search and register a company name, click here to find out more. The rest of the processes, then follow.

Limited Liability Partnership

This is more or less a go-between limited liability companies and the standard partnerships discussed above. The owners benefit from the limited liability clause while at the same time enjoy the tax advantages and flexibility of partnerships.

This is suitable for professionals setting up businesses with the hope of attracting fellow professionals to join them either at the onset or later in the business. It is important to point out that this is the newest business structure in the UK.

Whichever legal form works for you, go for it! In case you encounter challenges during formation, there are professionals knowledgeable in this space and are ready to hold your hand.