Choosing the right business structure

Posted 18 Sep

Choosing the right business structure

Starting a business can be daunting between sales, marketing, and day-to-day financing, plus there is the big question of which business structure to use.

The three most common types – a company, a partnership, or a sole trader – have very different cost and administrative burdens, as well as different implications when it comes to legal status and liability.

1. Going it alone as a sole trader: A sole trader structure is where one person owns and runs a business.

The benefits of operating as a sole trader lie in its simplicity. It’s extremely easy to set up, and tax-wise, all a sole trader needs to do is report their profits or losses in their personal tax return. What’s more, being a sole trader doesn’t prevent you from having employees if you want to grow your business.

However, a sole trader structure can be risky. As sole traders have ‘unlimited liability’, if the business runs into any financial or legal trouble, then you are personally liable for the fallout (this makes a good insurance policy all but a necessity for this kind of structure). It can also be difficult to attract outside investment as a sole trader, as you have no shares or equity to offer potential investors.

2. Working within a partnership: Put simply, a partnership arises when two or more people go into business together.

Partnerships can be a great way to pool knowledge and resources, making it cheaper and easier to start and maintain a business. From an administration perspective, partnerships are also extremely easy to set up, though a partnership agreement (and a written confirmation of the partners’ profit-sharing arrangements) should still be documented, as this will help avoid any potential disputes in future.

Partnerships are also relatively stress-free from a tax perspective. This is because (unlike a company) partnership profits aren’t paid at the partnership level. Instead, partners report their share of partnership profits in their personal tax returns, with those profits subject to tax at the partner’s marginal tax rate.

However, there are downsides to a partnership. For one, partnerships are more work than a sole trader structure, and they don’t benefit from the legal protection that a company offers. This means if the partnership ends up in debt, the partners are typically liable to repay those debts jointly and severally. There are ways to reduce this risk (for example, by forming a limited partnership) but this is best navigated by taking legal and professional advice.

3. Operating as a company: A company is a legal entity, separate and distinct from its owners (known as shareholders). A company may have one shareholder, or many.

One of the big draws of a company is limited liability, with a shareholder’s financial liability typically limited to the amount they’ve invested in the business. Companies are also an attractive structure to consider if you ever want to bring on external investors, or if you think you may ultimately sell your business down the line.

However, companies have their downsides. For one, they cost more to run compared to a simple sole trader structure. In addition to initial set-up costs, companies must also comply with various legal and regulatory requirements, including regular accounts preparation and tax return filings.

In addition, because of the legal separation between a company and its owner(s), remember that any funds in a company’s bank account belong to the company and not the directors or shareholders. Any extraction of funds from a company is therefore typically achieved through a mix of salary, dividends, or, in specific cases, a director’s loan account. It’s best to speak to an accountant to decide which combination would best suit you and your company’s needs.

Choosing a business structure is always a very personal decision. If you need help deciding which one is right for your circumstances, contact us to book some time with our team today, we’d be happy to discuss the best option for you.

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