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How to Choose the Best Legal Structure for Your Business in the UK

How to Choose the Best Legal Structure for Your Business in the UK

When forming a company in the UK, most people choose to form a Limited Liability Company.

Although this is a popular legal structure in the UK, it is not necessarily the right company structure for you, depending on what your goals and services are.

The UK allows you to incorporate your company using various different vehicles. In this article, we’ll cover all the different types of company structures that exist in the UK so as to help you choose the right one for you.

 

Not legal advice

Just a quick note that nothing below should be taken as legal advice. We are purposefully providing an “oversimplification” of matters here in order to convey certain high-level concepts.

We also do not know your particular circumstances and so are not qualified to offer legal advice.

Be sure to seek professional and qualified legal counsel for any matters of law before taking any decisions.

 

What is meant by a “legal structure”?

When you are a sole proprietor, your personal finances and your company’s finances are interlocked. One cannot be separated from the other. You are personally liable for the company’s debts as well as for any damage caused by the “company”.

Let’s say you are in computer repairs and someone pays you to come over and repair their computer. They then claim that your service further damaged their computer, causing them to be unable to work for seven days. They claim that they lost £1,000 in revenue in those seven days.

If they sought legal action against you, then you would be liable for those damages if found guilty, and you would have to pay those costs from your own pocket.

There might be ways to mitigate this kind of risk, such as by signing for the right business insurance.

But a more common approach is to separate the two legal entities and make the company a “legal person” on its own, and you another legal person.

Using this legal structure, you separate your own “existence” from the company’s existence, and you are both treated, in the eyes of the law, as separate legal persons with rights unto each other.

 

“Incorporate” means “giving a body to” something

The word “incorporate” comes from a Latin word which means to “form into a body”.

The word is used, for example, in fantasy novels or in religious contexts when a spiritual entity is given a physical, tangible form.

The same is true of forming a company — an intangible idea is given a tangible form (bank account, physical office location, registration at Companies House) and is thereafter treated as its own “legal person” which is accountable for its actions and liable for its debts.

The caveat, of course, is that the company’s money belongs to the company, not to you. Taking money without permission from this particular legal entity equates to stealing. To obtain money from this separate entity, you must either:

  • Receive a salary
  • Receive dividends after following the appropriate legal procedures for obtaining those dividends.

For example, if your company is not deemed to be profitable, then it is illegal to obtain a dividend payment from it in the UK.

You are also not allowed to demand a dividend payment from a company unless you own a controlling amount of shares in it.

 

Sole proprietor

A sole trader is also known as a sole proprietor, freelancer or self-employed person.

The biggest pro to operating as a sole trader is that you are allowed to keep 100 per cent of the profits of your business.

The biggest con is that you are personally liable for all debt your business incurs.

Setting up as a sole trader is also the easiest of all the legal structures. You simply go on over to the HMRC to register for self-assessment the second you start trading.

Sole traders are also allowed to employ staff, in which case they must follow all applicable employment laws .

Sole traders must keep records of their business’s sales and expenses, and file a self-assessment tax return every year.

If you earn more than ÂŁ85,000 a year (gross), then you are obliged to register for VAT. But you are also able to register voluntarily regardless of whether you hit this threshold.

Registering for VAT makes sense if you make a lot of B2B purchases and want to claim back the VAT for them.

Sole traders can trade under their own name or create a different business name, but there are certain restrictions you need to be aware of in the case of the latter.

 

Limited Liability Company

A limited liability company is a legal structure that limits the personal liability of shareholders for debts, to the amount of initial capital invested in the company by them.

That means that, if you invested ÂŁ1 in initial capital to open up your Ltd, then your personal liability is limited to just that ÂŁ1.

There can be exceptions, of course. If it is proven that you, as a director, have acted in bad faith with regards to the company’s finances and creditors, then you might be held personally liable for your company’s debts.

Also, if your Limited has not kept up with its corporate taxes, HMRC might demand that you, as the director, pay those taxes in certain circumstances.

But, overall, when business is conducted in good faith, your personal liability is indeed limited by your initial share input.

Limited Companies might or might not be the right choice for you, depending on the purpose and activities of your business.

Limited companies require more setup than starting up as a sole trader. They also have more initial costs.

A limited company’s annual reports and financial accounts must be placed in the public domain, as opposed to a sole proprietor’s accounts which are kept private.

Difference between a shareholder and a director

In a limited company, the shareholders “own” the company and the directors “run” the company.

You can, however, be both a director and a shareholder.

In the UK, only one director and shareholder (which can be the same person) are required to form a limited liability company. Therefore, it is not uncommon to find “one-person-shows” that are incorporated as limited companies.

You can also register a company secretary if you wish, although this is not a requirement in the UK.

There are different numbers of minimum shareholders required in different parts of the world. There are also different rules for whether the sole shareholder and director can be the same person. In Ireland, for example, you will need to appoint a separate company secretary to the director, to form a company. (We can act as the secretary in your Irish company when you  .)

If you structure your dividend payments right, it is theoretically possible to reduce your final tax payout by as much as 20 per cent when you register a limited liability company. This is one of the main reasons why so many people decide to set up a limited company in the UK.

 

Ordinary (General) Partnership

A crude idea of an ordinary partnership is “two sole traders who are working together”.

Each partner must register as a sole trader with HMRC and file a self-assessment tax return at the end of the year.

In an ordinary partnership, each partner shares liability for the business.

The partners will share losses, expenses, and profits. Each partner will pay their own respective tax on their share of the profits.

When setting up an ordinary partnership, it is necessary to choose a name in accordance with the usual rules of naming a business, i.e.:

  • Cannot use “Ltd.” or “Limited” in the name
  • No offensive words
  • Cannot conflict with an existing trademark.

You need to name your “nominated partner” and then register the partnership with HMRC. It is the “nominated partner” who is ultimately responsible for record-keeping as well as for managing the partnership’s tax returns.

One of the benefits of forming a partnership is that it is relatively easy and flexible to set up in comparison to a Limited company. There are also less annual filings and administrative demands from HMRC than in a Limited.

The con, of course, is this matter of shared liability. It is also possible that the liability continues even long after one of the partners leaves the partnership.

 

Limited Liability Partnership (LLP)

The main difference between an LLP and a General Partnership is that the LLP will become a separate “legal person”.

As such, liability for company debt is limited to the initial capital invested in this partnership upon its formation.

An LLP must have at least two “designated members”. These designated members are responsible for the filing of the partnership’s annual accounts. There is no limit to the number of partners that an LLP can have.

An LLP’s partners can be natural persons or legal persons, by which is meant that any of the partners can be a sole trader, limited company, another LLP, etc.

In a Limited Liability Partnership, each partner’s assets and wealth are protected. Their individual liability is limited to their initial investment as well as any personal guarantees made by them when raising loans.

The share of profits each member is entitled to, is determined by an initial members’ agreement.

The LLP must be registered at Companies House.

LLPs share attributes of Limited Liability Companies as well as General Partnerships.

Each individual partner is taxed as an individual, and there are no corporate taxes to be paid, much like a sole trader. But the partners have limited liability for company debts.

In some cases, this legal structure might be more tax-efficient than a limited company because there is no “double taxation” situation (corporate taxes on company profits and then personal taxes on dividends). Partners are taxed as individuals, and that’s it.

There is also less annual paperwork and administrative burden involved in setting up an LLP — such as no need for an LLP to hold board meetings or shareholder meetings, or to have to make decisions by resolution.

The members’ agreement which forms the LLP is not a matter of public record.

If an LLP does not trade within one year of formation, then it will be struck off.

Private Company Limited by Guarantee

This is a popular structure for non-profit organisations.

There are no shareholders in a company limited by guarantee. Instead, designated guarantors will put up a “guarantee” amount for the company’s debts and will be responsible for those debts up to that amount only.

This means that the guarantors’ personal finances are secure.

This structure is popular with sports clubs, membership organisations and charities.

Companies limited by guarantee are separate legal persons from the guarantors and have separate finances. A company limited by guarantee generally does not distribute any share profits or dividends but invests profits back into the company.

If the company does decide to distribute any of its profits, then it will not be able to apply for charitable status.

A company limited by guarantee must be registered at Companies House.

This is not the only choice available for charities. A charity might also choose to be structured as a:

  • Charitable Incorporated Organisation (CIO)
  • Unincorporated Association

 

Unincorporated Associations

If a group makes an agreement to come together for any reason other than to make a profit (e.g. a sports club, or another type of club) then it is considered an Unincorporated Association.

There is no need to register such an association and therefore no costs involved in establishing one (other than the costs the individual members decide to invest out of personal choice).

If an unincorporated association begins to make a profit, then it will need to pay corporation tax and file annual company tax returns.

 

Public Company Limited by Shares (PLC)

A PLC has shares which can be purchased openly, such as at the London Stock Exchange.

If you see that a company has “PLC” after its name in the UK, that denotes that the company is a Public Company Limited by Shares.

Examples of such companies are:

  • BAE Systems PLC
  • Associated British Foods PLC
  • Experian PLC
  • Tesco PLC.

Whereas private limited companies may not offer their shares for sale to the public, PLCs may.

As is the case with private limited liability companies, a PLC shareholder’s liability is limited to the amount of capital initially invested in the company.

The minimum requirements for incorporating a PLC in the UK are:

  • Must have a minimum of two shareholders
  • Must have public shares issued to the value of at least ÂŁ50,000
  • Registered with Companies House
  • Must have a minimum of two directors. At least one director must be a natural person (i.e. not another company).
  • Must have a company secretary that is qualified to carry out their duties.

PLCs are the preferred vehicle for extremely large companies who require raising capital through the trading of shares.

 

Factors to consider when choosing a legal structure for your company

If the above choice of legal structures doesn’t immediately answer your question of what type of legal structure to choose for your business, then it might be time to ask for expert help in forming your company.

Here are some questions to ask yourself, and factors to consider, to help you work out which structure might be best for you:

Are you a one-person show who wants to turn a profit? The clear choice here is either a sole trader or Limited Liability Company.

If there’s little risk of you incurring debts you cannot pay, a sole trader choice might be simpler for you because there is less annual administrative burden.

If you don’t have a lot of free time on your hands for annual accounts and tax returns, again, sole trader might be the way to go. Alternatively, you could hire an accountant to take care of that for you so that you are free to focus on your business.

If there is any chance whatsoever of your company incurring debts it might not be able to pay, despite your sincere efforts to cover them, you should then choose one of the limited options — Private Limited Company, Limited by Guarantee or Limited Partnership.

If you are in business to turn a profit, skip Limited by Guarantee. A Limited Partnership or Private Limited Company will serve you better.

If you must work together with someone else, either a Limited Partnership, General Partnership or Limited Company might be the best choice for you.

If you want to keep all the profits without having to jump through hoops to get them out of the company, an LLP is an easier choice than the Ltd.

Generally speaking, a Ltd offers better tax advantages in the UK because the UK’s corporate tax is relatively low (currently 18 per cent).

If, however, you don’t expect the company’s profits to go much higher than the minimum personal allowance for income tax then an LLP might be a better choice as you will end up saving on tax.

Saving a few thousand quid at the cost of dozens of hours of personal lost time in additional administrative burden might not be worth it. As the saying goes, time is money, and you need to consider both when planning out your company’s legal structure.

You could offload all of that additional time by hiring an affordable accountant to take care of yearly accounts and still come out on top with a legal structure that is more favourable tax-wise.

Forming a company is a big decision and one that should be taken advisedly and with one’s eyes open. Expert assistance is crucial. The wrong legal structure can end up being a costly or time-consuming burden you must carry on your shoulders for many years.

The right legal structure for your company could be just the door you need to open to put you into the financially successful position you always wanted to be in.