Are You a Sole Trader or Do You Need a Company?
When they start out, all entrepreneurs must make a decision about the legal structure of their businesses. In other words, are they planning to be a sole trader, or do they want to establish a limited liability company? Some may also have the option of a partnership, or a limited liability partnership, depending on their business arrangements.
There’s no doubt that the easiest way to run a business is as a sole trader. An entrepreneur simply begins by registering with HM Revenue & Customs free of charge. The record keeping and accounting processes are also easy to follow: an entrepreneur just has to complete an annual self-assessment tax return, and maintain records of all business expenses and income.
Any profits from a sole trading business go straight to the entrepreneur. HM Revenue & Customs taxes these as self-employed income. The sole trader also pays fixed rate Class 2 National Insurance contributions, and Class 4 contributions based on the level of profit.
Finally, the sole trader is responsible for all the decisions about the business, and is liable for any debts. This last point means that property and other assets are at risk if the business experiences problems.
A limited liability company has a different financial arrangement to the above because it has its own identity. Its finances are therefore independent and not related to the personal assets of the company’s owners.
In other words, the shareholders of the company are only responsible for company debts if they’ve given a financial guarantee. If not, the shareholders’ personal finances are secure if the company fails (although shareholders may lose any investment they’ve made).
The two main types of limited liability company are private limited companies and public limited companies. Private limited companies have one or more shareholders but are unable to issue shares to the public. They must also have one or more directors.
Public limited companies have a minimum of two shareholders, two directors, and a qualified company secretary. Public limited companies must issue at least £50,000 worth of shares to the public before they begin trading.
Entrepreneurs must register limited liability companies, and file the accounts, at Companies House. Any net profits go to the shareholders as dividends, or stay as working capital for the business.
A limited liability company must also pay corporation tax on the profits. The directors are company employees, and draw salaries that are subject to income tax and Class 1 National Insurance contributions.
Those entrepreneurs who form a partnership share the risks and responsibilities of business. Each partner has an appropriate share of the profits, and for legal and tax purposes is self-employed. As with sole traders, there is no protection for the partners if the business runs into trouble.
To give themselves some measure of protection, many entrepreneurs prefer a limited liability partnership. This arrangement limits financial liability to the investment each partner has made in the business, and to any personal guarantees used to raise loans.
HM Revenue & Customs regards entrepreneurs in a limited liability partnership as self-employed. They must therefore pay Class 2 and Class 4 National Insurance contributions.
These are the basic choices an entrepreneur faces for the legal structure of a business. A business consultant or accountant can provide more information, if necessary.