limited company, sole trader, partnership or limited liability partnership?

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january 2006

Each trading form has its own advantages and disadvantages. Choosing the best option depends on what you want from your business. Becoming a sole trader is the most straightforward set up, while forming a limited company offers reduced responsibility for your business debts but also brings more paperwork and a range of extra legal duties. Partnerships allow two or more people to set up in business together, sharing the risks, the work and the profits, while limited liability partnerships (LLPs) are similar to normal partnerships but also offer reduced personal responsibility for business debts.

why form a limited company?

The main reasons people form limited companies are to protect themselves from personal responsibility for business debt, because they think credit will be more easily available from banks and the perception that dealing with a limited company is somehow safer and more reliable. There can also be tax benefits.

If a private company limited by shares gets into debt, the owners (shareholders) are not personally liable for the business debts or any claims made against the company. Generally, a limited company protects the individual from being sued and personal risk is restricted to how much is invested in the business and any financial guarantees given to obtain finance. This legal limitation, called ‘limited liability’ is created through registration at Companies House. The process is known as incorporation. Without limiting personal liability businesses would be legally responsible for company debts and personal assets would be at risk. With limited liability, personal assets can remain intact even if the business fails under a burden of debt.

Banks more readily lend to limited companies (especially where the directors have security such as equity in the form of property, insurance policies etc) but still demand personal guarantees. Money for the business can also be raised by allowing individuals or other businesses to subscribe to shares in the company and employees can also have shares.

Limited companies pay corporation tax on profits (under £10,000 is currently free) and rates vary above this level, (e.g. 19% over £50,000 to £300,000 at present). These tax advantages vary, but profits distributed through dividends are generally a tax efficient means of rewarding entrepreneurs for the commercial risks they take. Limited company owners pay themselves a salary which is subject to PAYE in the same way as any other employees. The company must submit annual accounts and tax returns to HM Revenue & Customs, plus any personal tax returns for the owner(s) of the company.

A set of accounts must also be sent to Companies House, making financial information about your business publicly available. Companies House also demand annual returns giving certain details on the company and its directors and shareholders. Many companies and creditors will only work with incorporated companies – for the obvious reason that they can confidently check certain financial facts through Companies House. Also the perceived marketing benefits of dealing with a limited company, and the credibility the word limited attracts should never be underestimated.

Audited accounts are also necessary for larger companies– anything with a turnover more than £5.6 million and a balance sheet total of less than £2.8, million. Perhaps that does not initially concern the new business owner, but it is a goal to bear in mind for the future.

The name of the limited company or liability partnership must be registered with Companies House when it is formed and it cannot be identical to others. There are certain restrictions on certain sensitive words such as ‘royal’,’ ‘institute’ or ‘group’. Check on Companies House website, if in doubt. If an individual is not immediately ready to set up the company but wants to reserve a name to be certain no-one else takes it this can be done on a renewable yearly or two yearly bases.

To set up a limited company you need to create a memorandum of association and articles of association, which covers important information such as who will be running your business and where it will be based. Duport can deal with all these issues quickly and efficiently and provide a registered office address if don’t have one. Most people use a formation agent to take away much of the hassle and paperwork involved in creating a new company. If you want a ready made company, perhaps because you would like to take control of a company instantly or like one of the names registered, you can easily obtain one. Consider a "ready made" company if you want an established company a few years old.

sole trader

Setting up in business as a sole trader is quick and easy. Sole traders make their own decisions and are in charge. They are personally responsible for any losses the business makes, which means your possessions, including your home could be at risk if you get into debt. It can be difficult to get finance as a sole trader.

You must keep a record of the businesses income and outgoings and there are certain tax obligations and timetables for paying tax. You must inform the Inland Revenue within three months of becoming a sole trader (see separate articles on tax). You can still take on employees as a sole trader and you are generally taxed as self-employed although this is not automatically the case.

partnerships

Having a partnership means sharing the responsibility of business. You might have more money and resources to invest, but you also share the risks. If things go wrong and one partner can’t pay their share of debts etc the other is responsible. One partner can make binding business decisions without the other’s consent, so you must have the highest confidence in the skills and integrity of your partner before venturing down this route. You should draw up a partnership agreement, setting out precisely how the partnership will be run and who is responsible for what, not to mention how the proceeds will be split. Use a reputable solicitor to prevent disputes and fallouts. Partners are usually, but not necessarily taxed as self- employed.

limited liability partnership

A limited liability partnership (LLP) shares many of the features of a normal partnership but also offers reduced personal responsibility for business debts. Liability is limited to the money they invested into the business and any personal guarantees they have given to raise finance.

Forming an LLP can be expensive and complicated and there are additional running costs such as making financial information publicly available by sending a copy of the annual accounts to Companies House. Annual returns need to be sent with details of the LLP and its members. Audited accounts are also needed, although companies with a turnover of less than £5.6 million and a balance sheet of less than £2.8 million are usually exempt.

Like partnerships, legal agreements need to be carefully drawn up setting out how the LLP will be run and how profits will be shared. Usually partners are self-employed, and again registration is needed within three months. Charities or not for profit organisations cannot form LLPs.

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about the author

Heather Harrison is a highly regarded member of the Duport team. Her thorough knowledge of small businesses, combined with her talents developed during a career as a well respected journalist, make her articles very popular with our readers. Heather has worked on a variety of weekly and monthly magazines, both in the consumer and business press.

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