If you are starting up a business you will need to decide what legal form you would like your business to take. If you are going to be the sole owner, you can be a sole trader: you will be self-employed and there is no legal business entity, even if you take on employees. Or you could form a limited company, which you could run with or without a company secretary as sole director and owner.
Alternatively, if there is to be more than one owner, then you can set up any of a limited company, a partnership or a limited liability partnership.
Which one will be best for you and how do you choose? There is no easy answer to this and which entity suits you best will depend on a number of things, including:
- whether you need a separate legal entity or not
- the level of limitation of your liability
- whether you will want to borrow money in the future
- the set-up and ongoing costs
- income tax, capital gains tax and corporation tax
- what level of profit you might expect from your business and how it is to be distributed.
Unless you have some specific requirements, the pros and cons of which you go for usually cancel each other out. We find that people tend to be more comfortable with companies as they have been around for longer and are better understood by most people, rather than LLPs which are much newer.
If you decide to be a sole trader, setting up is usually very simple to start with and, if things go well, you can always upgrade to become a limited company or partnership to benefit from the limitation of liability that you do not have as a sole trader and transfer your assets into the new legal entity. Partnerships that are not limited liability partnerships have rather gone out of fashion, largely because the law relating to them is now ancient (Partnership Act 1890!) and they cannot offer the protection from liability available under the limited liability partnership regime. So, for those businesses where there are at least two owners, the only options left are limited liability companies and limited liability partnerships. Public limited companies are not covered here as they require a minimum share capital of £50,000 of which at least 25 per cent must be paid up.
The differences between private limited companies and limited liability partnerships can be summarised as set out in the table below.
|Limited liability companies||Limited liability partnerships|
|Capital – minimum||1p issued and paid up||None. Partnership can be funded through debentures or unsecured loans, ranking equally with other unsecured creditors|
|Employment rights||Directors are also employees and are protected by employment law||Partners’ rights will be as set out in a partnership deed|
|Incentives and bonuses||Bonuses are subject to income tax and NICs and employer’s NICs. Share option schemes can be complex and potentially costly to administer||Bonuses paid by way of profit share is taxed at up to 41% and partners maintain control through the partnership agreement|
|Legal entity||Yes. Can enter into contracts and hold title to assets||Yes. Can enter into contracts and hold title to assets|
|Liability of owners||On a winding up shareholders’ liability is restricted to any calls on unpaid shares||On a winding up, each partner’s liability is limited to his or her capital contribution and specified partnership profits, although partners have joint and several liability for stamp duty land tax|
|Protection from risk||Shareholders protected under tort and contract law, although directors may be personally liable for negligence or financial misfeasance||Partners protected under tort and contract law, although partners may be personally liable for negligence or financial misfeasance|
|Tax on profits||Corporation tax payable on a sliding scale||Partners taxed on all profits|
These are just some of the elements that need to be taken into consideration and much will depend on the personal circumstances of the individual directors/partners. Companies tend to be cheaper and simpler to incorporate, although future borrowing may require directors to enter into personal guarantees.
We can set up limited liability companies very inexpensively; however, we do also highly recommend that where there are more than two owners that a shareholders’ agreement is also put in place. LLP agreements tend to be more expensive to draft. You may also want to take separate taxation advice.
If you have any questions regarding company formations or LLPs please contact Nicola Prior on 020 8761 2302.
Disclaimer: Nothing in this article is intended as legal advice. If you have a particular legal requirement you should take specialist legal advice from a solicitor based on the facts regarding your individual situation.