So you’ve taken the plunge and now you’re self-employed. You’re out one evening and somebody says you should be trading as a limited company. What’s that? It’s one sort of legal status a business can trade as. The choice of status itself is not a simple question to answer. A business needs to consider numerous complications ranging from tax to prestige to exit strategies.
By far the simplest is a SOLE TRADER, which is you on your own. Really small businesses generally trade under this banner.
It’s worth noting that in some circumstances, when investigating the viability of a business before taking on a more secure legal status, that pre-trading expenses incurred can be offset once the business is formed.
- It’s quick to set up
- No legal forms to complete
- Don’t have to pay for any professional advice when setting up
- Annual audit fees generally less
- National Insurance rates are lower than if a director of a limited company
- You benefit from your hard work
- If you sell any business assets chargeable for Capital Gains Tax purposes you can make use of the annual allowance
- No distinction between you and the business. If it goes bust, creditors can go after your personal asset, which could be your house
- May prove difficult to obtain credit from suppliers as no records are maintained on any public register
- Income Tax and National Insurance are chargeable on profits and not drawings
- There could be issues with Inheritance Tax if you pop your clogs
The second form of business status is a PARTNERSHIP where two or more people come together with a common view to go into business. They often bring complementary skills or other qualities to the venture where they will both benefit.
Partnerships were very common until a few years ago with professional firms, but then Enron went bust and their auditors Arthur Andersen were sued. The partners went looking for a legal form which secured their personal assets, more on that in the next section.
In general the pros and cons are similar to those of a sole trader, although in addition you may need to consider:-
- Enables persons with different skills work together formally
- The cost of set up can be shared
- Could be seen by the outside world as a more professional business
- The partners can set their own rules which can be simple and flexible
- Difficult to value the business in the event of it breaking up
- No legal statues to rely on
The debts of the business have to be settled by the partners, in the event of any partners not having sufficient assets the others have to meet the obligations
Enron’s collapse was the tip of the iceberg, and all over the world accountants started forming LIMITED LIABILITY PARTNERSHIPS commonly known as LLP.
In the UK, LLP was formalised by an Act of Parliament in 2000. An LLP is a hybrid of a partnership and that of a limited company
Some points to note are:
- At least two partners must be designated as members and have additional responsibilities.
- An LLP must register at Companies House and file an annual return.
- If you are a member of an LLP, the profits are taxable as they would be if you were a self-employed person and you are liable for Class 4 and Class 2 National Insurance Contributions.
LLPs, rather than a limited company, are also formed in the UK by white collar contractors, mostly for tax reasons.
- Has for most partners a veil of protection for their personal assets
- Formal structure and rules
- Could be good for marketing, public perception of the business
- Policed by Companies House, annual returns are required
- More expensive to set up
- For that matter same to wind up
Most businesses trade under the umbrella of a LIMITED COMPANY.
For all the SMEs out there, don’t get ahead of yourselves. By far the most common form of limited company is called a private limited company.
To trade on a stock exchange the business will have to be a public limited company (PLC). There are many more obligations on a PLC, but the one major difference is that a PLC can trade its shares publically.
So don’t go thinking your fledgling business is going to be the next Google and this will be the legal vehicle to pursue that dream of drinking cocktails on the beach. First and foremost a limited company is a separate legal entity to the shareholders. It’s an artificial person with its own rights and obligations.
Remember the Hatfield rail crash? Network Rail and the division of Balfour Beatty that maintained the track were charged with corporate manslaughter in connection with the accident.
- Limited liability for debts.
- Organisation may have an unlimited lifespan.
- Capital can be raised by issuing shares.
- A board of directors and management team control the business.
- Directors are salaried and pay tax in the normal way (along with Class 1 National Insurance Contribution).
- The business may be perceived as more professional than sole trader status.
- Costs associated with setting up and administering the business are higher.
- Stringent accounting and auditing procedures apply.
There is one other type of limited company, the COMMUNITY INTEREST COMPANY, commonly known as a CIC, has only been in existence for a few years.
This is a company whose objectives are primarily social rather than profit making. In order to become a CIC you must:
- Pass a community interest test to show that the purpose of the business is primarily social.
- Make sure that the memorandum of articles shows that you intend to benefit the community.
- Use the profits and assets for the benefit of the community not just to benefit you or your employees.
- Access to sources of finance aimed at social enterprises.
- Branding as a social enterprise which may provide a marketing advantage.