Choosing a legal structure for your start-up
If you’re starting a business, what is the best legal structure to set up as? A lot of start-ups are born from one person’s dream so many entrepreneurs begin life as a sole trader, but this isn’t your only option. The alternatives come with a few more administrative duties, but they also bring along a lot of benefits.
When it comes to choosing a legal structure, you have four main options:
- Sole Trader
- Limited liability partnership (LLP)
- Private limited company (Ltd)
As a sole trader, you run your business in your own name i.e. you and your business are a single entity. Administration as a sole trader is very simple as you do not need to register with Companies House (the UK registrar of companies), although you do still need to register with HMRC.
The major downside of operating as a sole trader, is that you have unlimited liability for all of the activities of your business. So if you have any legal disputes or outstanding debts, your debtors can claim your personal assets, even if your business collapses.
This is the same as the sole trader structure, but with more than one person:
- You and your business partners don’t have to register with Companies House
- Debtors can claim against the personal assets of each member of the partnership, even if the partnership is in financial difficulty.
The additional risk associated with a partnership is that all members share unlimited joint liability. So even if it is not you who’s made an error which incurs a financial cost, you can still end up paying for the consequences!
Usually, the members draw up a formal agreement, which states clearly how the profits and losses will be shared among the partnership, but this is a private document which does not need to be filed with Companies House.
Limited Liability Company (LLP)
This does what it says on the tin — it’s a partnership where the members have ‘limited liability’. This is a great benefit, but comes with additional compliance requirements; an LLP must be registered with Companies House and file its regular financial accounts.
An LLP has its own distinct legal entity, separate from its members.It can sue and be sued, own property and exercise legal rights in its own name.
As with regular partnerships, the LLP’s governance principles are set out in a formal agreement. This is a private document and does not need to be filed with Companies House.
Private Limited Company (Ltd)
This is the most common structure for a lot of small businesses. For start-ups in particular, setting up as an Ltd yields the greatest number of benefits, albeit with extra administrative tasks.
- The company has its own distinct legal entity. It can sue and be sued, own property and exercise legal rights in its own name.
- When you set up as an Ltd, you typically become a shareholder. If the company makes a profit, you can receive them in the form of dividends, which attract less tax than a regular salary would.
- Operating as an Ltd is useful when seeking investors. Investors can be given shares in the company, entitling them to share in the company’s profits and losses.
- Even if you have a lot of investors, the day-to-day running of the business remains the responsibility of the board of directors. The arrangements for how they will do this is set out in a formal document which must be filed with Companies House.
If you would like to learn more about which legal entity is right for your business, get in touch with The Start Up Academy and speak to someone from our team!