If you’re planning to start a business, you will need to decide how you want to trade, whether it’s as a limited company, partnership or sole trader. This will largely depend on how many people are involved, the type of business and how you want it to be run.
If you’re going into business alone, becoming a sole trader may be the best option. However, if you want to work with and employ a number of people, you can trade as a partnership or a limited company. But which one is best?
A partnership has a very different structure from a limited company in terms of accounts and liability. There are, though, advantages and disadvantages to both, so you need to know all the risks involved before you dive in.
Key features of a partnership
A partnership is similar to a sole trader business but, of course, a partnership must involve two or more people to own the business and share the responsibility. This can have its upsides and downsides, but the main points are:
- Tax efficiency. With a partnership, you draw earnings, as opposed to receiving a salary through PAYE. You also don’t need to make National Insurance contributions.
- There’s no need to register at Companies House or file annual returns, however, it’s usually recommended that a partnership agreement is made, which explains the business structure, legalities and each partner’s responsibilities.
- Joint and several liability. This is quite a big disadvantage, but this can be overlooked at the beginning (no one wants to think about what would happen if their business fails). Each partner is liable to the entire debt of the business.
- Regardless of each partner’s financial status, if one cannot afford to pay any debt back and goes bankrupt, the entire debt will be left to the remaining partner(s). Worst-case scenario, a partner may have to sell the family home to pay the partnership’s debt.
- If a partner leaves a partnership business (eg retires, changes job/career), they may still be liable if the business becomes insolvent later on. Some partners who leave a partnership choose to continue investing, because they often get a good return over the years. However, they could be brought back into legal dispute and liability clauses if the business becomes insolvent.
- Shared responsibility. This can lead to disputes and falling-outs. There’s the old saying: “A friendship founded on business is a good deal better than a business founded on friendship”.
As licensed insolvency practitioners, we’ve come across numerous partners who have realised too late just how liable they really are. If a partnership is the preferred type of business, all partners must be aware of what’s at stake and know exactly what they are getting into from the beginning.
What is a Limited Liability Partnership (LLP)?
This is a corporate structure that gives partners limited liability and has similar traits to that of a limited company, while keeping the tradition of a partnership. It gives partners the benefits of a partnership, but allows them to be only partly liable if things were to go wrong.
Key features of a limited company
A limited company is owned by its shareholders (usually the directors) and all profits generated belong to the company. The company debt remains separate from individuals.
- Directors of a limited company are not personally responsible for the company’s debt. If the company goes downhill, the directors and shareholders will undoubtedly be upset and worried for the business, however, the worry stops there. Their own personal circumstances will not be affected (eg their mortgages, savings and other personal investments are safe). However, if there has been any wrongful trading, this won’t apply. If the authorities can prove the directors have been fraudulent, they will be held personally liable.
- Work and life at home can be separated financially because setting up a limited company means there will be clear legal boundaries between the two. This in turn can help ensure good balance and wellbeing.
- A limited company must register and file annual returns at Companies House.
- Companies must pay corporation tax.
- There are more director duties and legal responsibilities.
- Higher accountancy fees.
- Some creditors might worry that if they are dealing with a limited liability company, they will have less protection against debts.
It’s impossible to tell how well a company may do in the future. If the business is a success, a partnership can be highly beneficial. However, if the business were to fail, would you be prepared to pay off the entire debt and put your own personal finances at stake? Regardless of the kind of business you want to set up or how many people you want to involve, you must consider all the risks (as well as benefits).
Always seek professional advice
This article provides only a basic introduction – it does not constitute legal advice. The law on partnerships in particular is complex, with little case law, therefore you should always consult a lawyer if you are worried about your personal situation in any partnership and indeed company.
Blog supplied by Keith Steven of KSA Group is the author of Company Rescue. He has been rescuing partnerships and companies since 1994 using the company voluntary arrangement method.