If you’re planning to go into business, one of the things you’ll need to think about is what kind of company you want to form. This decision affects a variety of things, from how much tax you pay to your responsibilities as a director, so it shouldn’t be made lightly – take the time to review all of your options and choose which one suits you, and your business plan, the best.
The three most common types of businesses in the UK are sole traders, limited companies and partnerships. This guide outlines some of the advantages and disadvantages of each – a specialist formations company will be able to give you more information and guide you through the process of starting a business.
Sole traders are probably the easiest type of business to set up and administrate – you will need to register with HMRC as self-employed and complete an annual self-assessment, but otherwise your accounting and paperwork is minimal. As a sole trader, you have complete control over your business and the way it is run – meaning you keep all the profits of your business and do not have to answer to
However, doing business as a sole trader also has some pretty big downsides. You have unlimited liability, which means your savings, possessions and even your house are at risk if you run up large debts. They may also find it more difficult to secure larger contracts from bigger clients, who often prefer to deal with a limited company. Sole trading also makes it difficult to expand your business and take advantage of economies of scale (ie buying in bulk), and are taxed at a higher rate than limited companies.shareholders. Your business’ data is also kept private, unlike that of limited companies who need to make their information public after registering with Companies House.
Forming a limited company means you are creating a separate legal entity to trade under. In practice, this means your liability is limited to the amount you have invested in the business – in other words, your assets are not at risk if the business ends up incurring debts (as long as no fraud is involved!) Limited companies are also eligible for tax advantages, and give their directors more room to manoeuvre when it comes to arranging their accounts in a favourable way – for instance, you can pay yourself an amount that puts you under the high-earner tax threshold and invest the rest of the profits in the business.
The main downside to running a limited company is the red tape – you will need to prepare and submit annual accounts, tax returns and other documentation for HMRC and Companies House. As your business gets larger, you will probably need to hire accountants and solicitors to take care of this side of things. Your company records and data will also be made available to the public.
Partnerships are treated by Companies House, HMRC and the law in a similar way to sole traders. In a partnership, each partner shares the profits, liabilities and decision-making. They are less costly and time-consuming than limited companies to administer, and the nature of partnerships means you may start your business with more capital and greater flexibility than you would as a sole trader.
The biggest disadvantage of operating as a partnership is the risk of partners disagreeing, which can be disastrous for the business. For this reason, many partnerships draw up a document stating exactly how disputes will be resolved. Like sole trading, partnerships are also subject to unlimited liability, although the liability is spread over all partners.