By Steven Mather
This article provides an overview of some of the key legal issues when considering whether your business should be a Limited Company, a Sole Trader/Partnership or a Limited Liability Partnership (LLP) .
The first point to note though is that for many it is a tax decision – will I pay more or less, it isn’t quite as simple as that. It is important to consider all the factors first.
Most businesses start as a sole traders. The Gary Vee “side-hustle” as the internet loves to call it. The new business venture started while working full time. It’s pretty easy to do, you basically just start up. Aside from notifying HMRC that you are self-employed, which I guess not many people do when they are side-hustling, all you need to do is make a start.
However, it is not necessarily straight-forward to turn a sole trader into a limited company, particularly if the business has established itself and become more complex. It technically requires the limited company to purchase the business (for money or otherwise) and so it is always better to plan ahead and consider the conversion at the earliest stage possible.
The big attraction to a limited company is that of limited liability. Being a sole trader, you and the business are the same legal entity. You are the business. You are personally liable for the debts of the business and if the business fails, you may go bankrupt.
A limited liability company is a separate legal entity to its shareholders and directors. Technically speaking, if you have 100 shares of £1 each, then your total liability is £100. The reality is, of course, for many small business limited companies, is that if the business fails you wont have any money and so there is still a lot of risk. However, limited liability means that you cannot easily be sued for the company debts or contracts that the company takes out (except in cases of fraud for example).
Limited Liability means that you as a director and shareholder can protect your personal assets from company creditors (unless you give a personal guarantee). So even if the business fails, your house is safe. That said, as the business grows, banks, landlords and suppliers can sometimes require directors to sign personal guarantees which changes things.
Money is generally an important part of business, isn’t it?
Some businesses need money (capital) to start up. If you’re a sole trader, then this can actually be easier to obtain at a small level – but it will all be personal debt. Things like overdrafts, credit cards, personal loans and so on, are all easy ways of raising capital for your business but comes with personal liability.
As you grow, most investors and lenders will want you to be a limited company.
If your business is more than just you, then being a limited company helps manage and control the ownership and decision making process.
A limited company is made up of shares, say 100 shares in total (although it can be any number). This total can be divided up however you want. So if it is just you, you would own 100 shares so 100%. If it was you and your wife, you might own 50 shares each, or it might be a 90/10 split or however you want.
Shares equals votes and profit share. So in a 50/50 company, it means that no one person can make important decisions which can lead to deadlock if you fall out. However, it also means that each take out an equal share of profits.
If you are looking at starting with business partners or think you’ll want to at some point, then a limited company is a good idea, along with well written articles of association and a shareholders agreement – both outside the scope of this article but covered elsewhere here.
I’ve seen it said that trading as a limited company makes a business look bigger and more credible. I don’t agree, as if it is just you still, then your customers and suppliers are buying into you and not the limited company.
However, certainly if you’ve business growth in mind, then the structure that a limited company offers will inevitably make things appear more impressive.
This is an important area and you should always get independent tax advice from your accountant before making decisions. In general, having a company might be more tax efficient for a number of reasons:
- If you don’t personally need all the money you make, and keep profits in the business, you’ll pay less tax
- It is generally more tax-efficient to pay dividends
- Company directors are able to claim certain tax-free benefits and other benefits can come off the company tax bill too
- The company can pay into your personal pension and minimize both company and personal tax.
Compliance and Regulation
The downside of trading as a limited company is there is more compliance and more paperwork. You’ll need to do business accounts, business tax accounts, payroll for employees (including you as a director) and if you’re not a paper/admin person then you’ll certainly need external help with it all, which of course comes at a cost.
Overall, there are a number of perceived advantages to being a limited company over a sole trader, but as stated at the outset it is important that you take into account all factors first. You should always speak to professionals – lawyers and accountants – if you’re unsure on anything.