Entrepreneurs are likely to have a great business idea, coupled with a strong business plan, and cashflow forecast, but when starting a business, the structure of that business is one of the most important decisions that entrepreneurs are likely to make. Not only does it impact on how much tax is to be paid, but it also determines the level of potential liability going forward.
There are several basic ways in which business can be structured and, in this article, we will look at the most common of these business media in turn.
Conducting business personally, as a sole trader, is one of the simplest business mediums. A sole trader and the business are considered as one and the same entity, meaning that the business itself has no legal status, or identity, of its own. Due to this intertwined status, sole traders enter into a contract in their own personal capacity and thus have unlimited personal liability arising in connection with that contract.
Unlike partnerships and companies, sole traders are not regulated by any specific legislation and are merely subject to the relevant legislation affecting commercial/tax aspects, as well as the accounting rules and, where relevant, the common law.
A partnership is defined as “…the relation which subsists between persons carrying on a business in common with a view of profit”. Due to this wide definition, many different types of partnerships can take place and, due to it applying irrespective of intentions, business can be conducted as a partnership unwittingly.
As no express written agreement is necessary, some businesses are conducted by way of an informal understanding, such as family businesses. Others, especially larger and professional businesses with a number of partners, such as law firms, would ordinarily have a partnership deed drawn up that governs the relationship between the partners.
Similarly to sole traders, and even though partnerships are governed by statute, they have no separate legal identify. Contracts are therefore entered into by individual partners who retain personal liability.
Limited Liability Partnership (LLP)
An LLP is generally considered as a hybrid, in that it retains the benefits of a partnership with the advantage of a limited liability for its members.
Unlike partnerships, LLP is treated as a separate legal entity from its members due to it being considered as a body corporate. An LLP may, therefore, enter into agreements in its own name, yet limit the liability of its members to an amount that members agreed to pay under the terms of their partnership agreement.
Company Limited by Shares
As an LLP, a company has a separate legal identity from its owners (shareholders) and may thus enter into contracts in its own names.
Companies limited by shares are governed by Companies Act 2006, as well as other relevant legislations, and the common law, where applicable.
The shareholders liability is limited to an amount, if any, unpaid on their shares, and the relationship between the shareholders is governed by the company’s articles of association, which acts as a contract between the shareholders themselves, as well as between the company and its shareholders. It is, however, not uncommon for shareholders to have a private agreement, too.
Company Limited by Guarantee
It is relatively rare for companies to be limited by guarantee, but instead of holding shares in the company, members will guarantee that if the company is ever wound up, they will contribute a certain amount to the funds to be distributed to that company’s creditors. It is common for such guarantee to be in the region of £1.00.