How to choose the right business structure

When you start a business, there are several different ways you can choose to operate. Each option has different tax treatments and rules, so choosing wisely for your needs is important.

Even if you’ve been self-employed for some time, it’s often the case that as your business grows and changes, the most appropriate structure changes too.

Here, we explain the differences between the three main options and how to work out which will be the best fit for you.

Types of Business structure

The three main types of business structure are sole trader, partnership and limited company, and the key differences between them stem from ownership, liability, responsibilities and financial circumstances.

Sole trader

Sole traders own their businesses outright and don’t have any partners. In this setup, you’re responsible for all the decisions, and you and your company are legally considered a single entity. You get to keep all your business’s profits after you’ve paid income tax on them, but you’re also personally responsible for any losses. It’s the most straightforward and most common structure used by self-employed individuals and small businesses.

For more tips on being self-employed, check out our dedicated guide to self-employment. 

Pros and cons of being a sole trader

Pros:

• It’s quick and easy to set up
• Less admin than with a limited company
• You keep all your profits after income tax
• You can start trading immediately, subject to any insurance or licences you need
• You can still employ staff
• You retain complete control of your business
• Your accounting can be more straightforward – HMRC calculates your tax after you submit an annual tax return

Cons:

• You are personally responsible for your company’s debts - in the worst-case scenario, you could be made bankrupt, and your personal assets (such as your home) sold to pay your creditors
• You are personally responsible for any legal issues your company has
• You may be missing out on tax advantages – you can’t defer profits to future years, for example, and you can’t claim dividends
• It’s harder to pass on the business through inheritance or sale
• You must keep records of your business income and expenses – HMRC lists everything you’ll need to track

Sole trader tax rules

If you decide to set up as a sole trader, ensure you notify HMRC within three months of beginning trading. You may also need business insurance to cover your venture – see our guide to insurance for traders for more details.

Sole traders must pay:

• income tax on all profits at the marginal rate
• Class 2 and Class 4 National Insurance
• VAT if you earn more than £90,000 in taxable turnover per year (you can choose to register for VAT if you earn less than this).

Partnerships

Partnerships can operate in a similarly straightforward way to a sole-trader structure but involve more than one owner. Each owner is jointly responsible for the business’s debts and bills. If any partners leave the business, then the remaining partner(s) are responsible for all debts. Partners also share the profits from the business, with each paying tax on their share.

A partner isn’t always a person. For example, a limited company counts as a ‘legal person’ and can therefore be a partner. You also need to follow certain rules about naming your partnership, and you will need a registered address.

Pros and cons of partnerships

Pros:

• You share the responsibility
• You share the risk
• You have access to the skillset of each partner

Cons:

• You will lose some measure of control over your business structure
• If the partners’ business goals are not compatible, it can lead to a difficult working environment
• You may be missing out on valuable tax advantages that you’d get by incorporating (setting up as a limited company).

Some businesses start out as a simple partnership, but then choose to change status to a limited company or a limited liability partnership. Whichever type of partnership you choose, ensure you have a partnership agreement in place to create the correct legal framework for the business.

You can use an off-the-shelf template, which you can find online, but it’s probably a good idea to take legal advice. See our article on how to find a lawyer for more information on getting good legal support. It’s important that all partners share the same goals for the business and will work together to achieve them.

Limited liability partnerships

An alternative partnership structure that provides more protection against personal bankruptcy is a limited liability partnership (LLP). This is a more complex business structure and must be registered with Companies House, where all basic business information must be on public record – much like a limited company.

You need to have an LLP agreement that sets out how the LLP will be run. This should include details explaining:

• how profits are shared
• how decisions are made and who needs to agree on them
• the responsibilities of each member
• how members can join or leave the LLP.

Limited company

A limited company is legally separate from the individuals who set it up, so it’s responsible for its own debts. If things go wrong, it’s the company that goes bust, not you – as long as you can establish that you have run the operation legally and in good faith.

Limited companies can also add to your credibility if you’re dealing with other businesses. On the downside, you’re required to submit annual accounts to Companies House, and there’s an increased level of administration and government regulation to deal with.

 Pros and cons of limited companies 

Pros:

• The separation of your personal and business finances – you won’t go bust if your business goes under
• Increased credibility with other businesses – limited companies can be seen as more substantial than sole traders, partly because of the complexity involved in setting up and running them
• The ability to keep profits within the business – this can reduce your tax bill, as corporation tax on profits is generally lower than income tax for individuals or partners
• You can reduce your tax bill by paying small salaries and high dividends, which aren’t liable for National Insurance contributions
• It can be easier from a legal or a tax perspective to sell an incorporated business when you retire than it is to sell a sole trading or partnership structure
• You can raise money from outside shareholders via the Enterprise Investment Scheme, which gives tax breaks to investors in small unquoted companies

Cons:

• You will have to register the business and pay annual fees to Companies House
• Increased administration and government regulation
• Your business’s accounts may be more complicated and costly to produce, requiring auditing, even if your turnover is low
• Your business accounts will be public
• You must make National Insurance payments both as an employer and as an employee if you draw a salary above £153 a week

Limited company tax rules

Limited company directors must pay:

• income tax
• dividend tax
• National Insurance

The company must pay:

• corporation tax
• VAT if it earns more than £90,000 in taxable turnover per year (you can choose to register for VAT if you earn less than this)
• National Insurance contributions
• Pensions (if you employ people)

There are lots of things to remember if you choose to set up this type of business structure, from choosing a company secretary to identifying people with significant control over the company. You’ll also need to keep records; it may be worth employing an accountant to handle the setup process for you and file company accounts when needed.

Review your business structure

Remember to keep your business structure under review as it develops. It’s relatively straightforward to switch from sole-trader status to a partnership or a limited company. However, you may wish to consult an accountant before taking this step. If you don’t already have one, see our guide on  for tips on finding one that suits your business. 

There are a few things to consider when choosing a different type of business structure:

• You will need to amend all paperwork to reflect the changes, and also your website, in line with The Companies (Trading Disclosures) Regulations 2008 and e-Commerce Regulations. 
• If you have switched from being a sole trader to a limited company, you’re legally required to open a business bank account. The company is a separate legal entity from you, so the money must be separate from your personal bank account. 

If you were thinking about how to legally change the name of your company to reflect your growth, see our guide on how to change the name of your business.

Any Which? Trusted Trader changing its business structure will need to sign a new agreement with us as a new legal entity. We would also need to see its accounts after six months of trading activity. It’s a good idea to clearly state the name you were formerly trading under on your Which? Trusted Trader profile page, so consumers can see any changes to the legal entity.

For traders who haven’t registered with Which? Trusted Traders, we offer unlimited trade categories to tag your business against, so your Which? profile can keep up with your company’s growth. Check your eligibility to join the scheme and become a Which? Trusted Trader.