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.
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:
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.
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.
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.
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).
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.
If you’re thinking about starting up, you must carefully consider whether to form a limited company straight away or hold off for a while and become a sole trader.
You may think forming a limited company will save you tax and must therefore be the best route. However, many start-ups incur considerable costs in their initial months. And even if you do not have sizeable initial outgoings, you should still factor in a realistic margin for error in your budgeting.
You will more than likely have a “learning curve cost” if this is your first time in business or if you’re going to be operating within a sector of which you have no prior experience. In either case, you should not expect the same return straight away as your more experienced competitors.
If you make a loss as a sole trader, it can be set against your employment income for previous years, which in all likelihood will give you a handy refund after the first tax year. If you make a loss as a limited company, it can only be carried forward and set against future the company’s profits. If the company never makes a profit, it will be wasted.
Even if you’re more confident that your business plan will be a success, you may still profit from waiting until you form a company. As a sole trader, you can build up custom, contacts, brand awareness and reputation in the business. From a tax point of view, this goodwill can be sold to the company. Future drawings from the company can be taken in the form of a director’s loan repayment, which will be especially beneficial if you expect to be paying tax at a higher rate.
You can set up as a sole trader by simply telephoning HMRC or registering online, whereas the route for a company formation is more complex. Ongoing accountancy costs are bound to be higher and Companies House will publish your company’s financial results for anyone to see – including your competitors, suppliers and potential clients.
Yes, if your salary and dividends are organised properly, a company can save you considerable tax. It can also limit your liability to company debts. But the decision is not so straightforward. If you want to protect your trading name, you can always form the company and leave it dormant at Companies House until you are ready to start trading.
A limited company can save you tax in certain situations, but it is not always the best way to start out. A brief review of the options with your accountant could save you time and money in the long run.
Why do people who should know better continue to give credence to the myth that it’s difficult to start a business?
A recent high-profile example of this came a few weeks ago on Sunday morning on the BBC’s Andrew Marr Show and it was uttered by no less a figure than would-be Prime Minister David Cameron.
Detailing measures he would take to aid small firms (and so the economy) if the Tories win the General Election, he said: “It takes something like 13 to 14 days to start a new [sic] business in this country. In America, it’s half as long. We have the ambition to make this [the UK] one of the fastest places in the world to start up a new business.” Later, this was reported on the BBC News website and others, but remained totally unchallenged.
It must be the party line. A few days later, shadow business minister Martin Prisk MP, in his ‘New year, new start, new business’ Blue Blog on the Conservative Party website, further fuelled the myth, saying: “We would cut the time it takes to start a new [sic] business in the UK. Currently, it takes twice as long as in the USA, Denmark or Hong Kong. Conservatives want to change that, so we would reduce the number of forms needed to register a new company and move towards a ‘one-click’ registration model.”
What type of business are they talking about? Have I missed something?
Setting up as a sole trader (AKA becoming ‘self-employed’) is likely to take 10 minutes tops. All you need do is call the HMRC Newly Self-employed Helpline on 0845 915 4515 to provide some key details (eg your name, DOB, NI number, address, telephone number, start date and type of business). You could even have been trading for up to three months previously (if you leave registration any later than three months, you’ll be fined £100). Should you prefer, you can register online. Where’s the problem?
And while forming a limited company (“incorporation”) takes slightly more effort (you need to fill out an IN01 form and complete a Memorandum of Association and Articles of Association), it can be done within a day if you pay £50 for the Companies House same-day service. Otherwise you’ll have to pay the standard registration fee of £20, which, granted, could take between eight and 10 days to process. Pay a professional to do it all for you and opt for the same-day service and your new company could become a legal entity in four hours or so.
So why spread the myth? Is it because our politicians are so out of touch with the reality of starting a business? Probably, yes. Few politicians of whatever persuasion have or will ever start or run their own small business. And that’s part of the problem, but one for another day.
And while it’s understandable that any party trying to gain power should seek to appeal to small firms and the wider electorate with the promise of a better new world, using untrue ‘facts’ (if you’ll forgive the deliberate oxymoron) merely increases the risk of putting people off, at a time when the economy needs them to start a business. We should encourage people to go into business – not discourage them.
Truth is, registering a business isn’t difficult and it doesn’t take a long time, the myth needs to be challenged (same as the ‘excessive red tape’ red herring). The real difficulty lies in surviving that all-important first 12-18 months and then moving the business onto the next stage. Any small-business owner would tell you that, Dave.
Mark Williams, Start Up Donut editor