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.
The three main options are sole tradership, partnership, or setting up a limited company. Depending on the size of your business, how much you’ll earn, and what kind of industry you’re in, there are different pros and cons to each approach.
Here we explain the main difference between the three, and how to work out which will be the best fit for you.
Sole traders own their businesses outright, and do not have any partners. In this set up, you’re responsible for all the decisions and your company are legally considered as one entity. It’s the most straightforward and most common structure used by self-employed individuals and small businesses. You get to keep all of your business’ profits after you’ve paid income tax on them, but you’re also personally responsible for any losses.
Sole traders must pay:
The advantages are:
The disadvantages are:
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 and local businesses for more details.
If you’re thinking of starting up as a sole trader, HMRC has a helpful step-by-step guide to walk you through the process and everything you need to do.
Partnerships can operate in a similar straightforward way to a sole-trader structure – only there is more than one owner involved. Each owner is jointly responsible for the debts and bills of the business. If one or more partners leave the business, then the remaining partner(s) are responsible for all debts. Partners also share the profits from the business, with each partner paying tax on their share.
A partner isn’t always a real person. For example, a limited company counts as a ‘legal person’ and can therefore be a partner.
Find out more about setting up a partnership in the HMRC guide.
An alternative partnership structure, which 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 a have an LLP agreement that says how the LLP will be run. This should include details explaining:
You also need to follow certain rules about naming your partnership, and you will need a registered address.
Again, the government has a helpful guide which lays out all the steps you must take when setting up a limited liability partnership.
Some businesses start out as a simple partnership, but then choose to change status to a limited company or a limited liability partnership.
Whether you plan to run your business as a simple or limited liability partnership, you should 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. It’s important that all partners share the same goals for the business and will work together to achieve them.
The advantages of a partnership are:
The disadvantages of a partnership are:
A limited company is legally separate from the individuals who set it up, so it is 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 are required to submit annual accounts to Companies House, and there is an increased level of administration and government regulation to deal with.
Limited company directors must pay:
You can read more about your responsibilites as a company director on Companies House.
The company must pay
The advantages of limited-company status are:
Disadvantages of limited-company status are:
If you’re considering setting up a limited company, use the government’s step-by-step guide. There are lots of things to remember, from choosing a company secretary, to identifying people with significant control over the company. You’ll also need to keep records, but gov.uk has a helpful list of what’s needed. It may be worth employing an accountant to carry out the set up process for you, and to file company accounts when needed.
You can also register for email reminders from Companies House to help you keep on top of when your company’s accounts and confirmation statements are due. Plus other useful tips.
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 consultant an accountant before taking this step. If you don’t already have one, see our article on finding an accountant for tips on finding one that suits your business.
If you do change your 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.
Any Which? Trusted Trader changing its business structure will need to sign a new agreement with us, as a new legal entity. Which? Trusted Traders 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 change of legal entity.