Whether you are forming your first business or adding to an existing one, it pays to set it up correctly. Choosing the wrong business structure will expose you to unnecessary costs and risks. Failing to address the key practical issues can result in you falling out with business partners or stakeholders. This briefing focuses on:
- The relative advantages of trading as a limited company, a limited liability partnership, a partnership or a sole trader.
- The mechanics of setting up a business, to comply with the law.
- Choosing a name for your business.
- The most important practical issues — agreeing the strategy and key operational and personnel issues.
1 Choosing the legal form
The legal form you choose for your business will depend on your commercial needs, the financial risk you are willing to take and your tax position.
1.1 Setting up a limited company offers flexibility if you plan to grow the business (see 2).
- A limited company is a separate legal entity, distinct from its shareholders, directors and employees. The business can continue despite the resignation, bankruptcy or death of directors or shareholders. The company can only cease as a separate entity through striking off or winding up.
- It is relatively easy to involve outside investors by selling them shares. It is always worth being careful about who you allow to become shareholders as they share in the ownership and possibly the decision making of the company.
- The risk of loss is normally limited to your investment, primarily in share capital. You risk greater losses if you stand as personal guarantor for any of the company’s debts or fail to comply with legal requirements.
Some of these benefits are also available in a limited liability partnership (see 1.3 and 4.6).
1.2 You may choose to operate as a sole trader if you are the owner-manager of a small business. Setting up is easy (see 4).
- You are self-employed. You personally own the assets of the business and are personally responsible for any profits or losses of the business.
1.3 You can form a partnership if two or more of you work as partners, sharing the profits or losses (see 4).
- You and your partners personally own the assets of the business. Any losses would normally be shared between you. But if others cannot pay their share, you are liable for their share, as well as your own.
- Alternatively, you can set up a limited liability partnership (LLP), in which individual members have protection from the partnership’s debts.
Although some businesses establish themselves as limited companies from the outset, many start life as sole traders or partnerships, then incorporate as LLPs or limited companies once they are ready to grow.
2 Limited company
Trading as a limited company can be a good way of limiting the risks of personal financial loss.
2.1 Your liability is normally limited to the amount you agree to invest in the company by buying its shares.
2.2 You can raise money for the business by selling shares in the company to interested parties, including other businesses.
- You may wish to tie in key managers by offering them a stake in the business.
2.3 Limited companies pay corporation tax on their profits.
- Directors and other employees can pay income tax on salaries and benefits through PAYE.
2.4 You must submit annual accounts and tax returns to HMRC, and file a set of accounts with Companies House to make information on the company’s finances publicly available. There are fines if you miss deadlines or submit incorrect information.
- Most small companies with a turnover of no more than £6.5 million and assets of less than £3.26 million do not need to have their accounts audited and so are not required to appoint an auditor.
2.5 There are a number of other statutory requirements that you must fulfil on an annual or ongoing basis.
- For example, you must let Companies House know about any change of directors.
3 Becoming limited
3.1 You can set up a new limited company with minimal effort using a company registration agent, or your accountant or solicitor.
- Check whether the agent you use is known and reputable.
- Most agents can also provide a full ‘company kit’ to save you time. It includes a company seal (if required), a combined register containing the required statutory registers, and all the necessary forms.
- Additional services might include providing a registered office and company secretary.
- As part of the process, you create Articles of Association — the rules governing how the company is run. For example, these set out any restrictions on what the company can do and how decisions will be made.
- You can use standard model Articles of Association, or change them to reflect your particular requirements. For example, you might want to include restrictions on transferring shares to other people.
3.2 To speed up the process, you can buy an ‘off-the-shelf’ (ready-made) company.
- An additional fee may be payable for changing details such as the company name and the amount of share capital.
- Many reputable agents can incorporate a company electronically on the same day for no additional fee.
3.3 You can complete the whole company formation process yourself, using the guidance notes and forms provided by Companies House (0303 1234 500).
- If you are happy to use the model Articles of Association, you can incorporate a private company online using the Companies House Web Incorporation service for a fee of £13.
- If you want customised Articles, you may prefer to use an agent.
3.4 When you are setting up the company, you must appoint at least one director.
It is no longer obligatory to have a separate company secretary.
4 Sole trader or partnership
Most small businesses operate as sole traders. If two or more people go into business together, they may choose to trade as a partnership. Partnerships can be a good way of sharing management burdens and making sure people commit to the success of the business. But be aware of personal liability issues.
4.1 You are personally liable for all your business debts.
- There is no limit to the extent of your liability. If you cannot pay off your business debts, you can be made bankrupt.
- In a partnership, each partner is liable ‘jointly and severally’ for all the business debts of the partnership.
This means that, if the business fails, you could end up having to pay your partners’ share of the debts, as well as your own. But for income tax purposes each partner is only liable for their own share of the profits.
4.2 You personally own the business assets.
- In a partnership, the assets are jointly owned, along the lines set out in the Partnership Agreement (see 4.5).
4.3 You pay income tax on any taxable profits.
- Your profits will be taxed at the appropriate personal rates.
- You pay tax on the profit, even if you have no actual drawings from the business.
4.4 Your National Insurance contributions (NICs) may be lower than if you are an employee of a limited company.
- A shareholder in a limited company may be able to take dividends without any NICs being payable.
- Ask your financial adviser whether your overall tax and NICs liability is likely to be lower if you are a sole trader (or partnership) or a limited company.
- There are restrictions on your entitlement to social security benefits.
4.5 In a partnership, it is normal to agree all your commitments at the outset in a Partnership Agreement.
4.6 You can limit your liability by setting up a limited liability partnership instead.
5 Choosing a name
5.1 You can trade under your own name, or choose a different business name.
- A limited company can trade under its registered name or use an alternative name, provided that the ownership and limited liability of the business is disclosed.
- Partnerships can trade under the names of all the partners or a business name.
- Sole traders who trade under anything other than their own name must declare themselves ‘sole trader’ or ‘owner’ or ‘John Smith trading as John Smith Antiques’ on their stationery.
5.2 Businesses are not allowed certain names.
- Check that the name, or one close to it, is not being used by another firm in a similar line of business.
- Check the Companies House Index of Registered Limited Companies and LLPs at www.companieshouse.gov.uk/info, or get a company registration agent to do it. This search will not include names of sole traders or partnerships, or ‘trading as’ names.
- In addition, agents can check the Trade Marks Registry for names which have been registered as trade marks. You can also carry out a basic check on the UK Intellectual Property Office website.
- The name must not be misleading — for example, about the legal status of the company — or offensive. Words such as ‘International’ may need to be justified.
- Certain words are prohibited. For example, ‘British’, ‘Royal’ and ‘Group’ unless their use can be qualified.
- You must not use ligatures, accents or diacritics in the spelling of the name, as these make it difficult for people to search for your company’s public records.
See booklet GP1 on the Companies House website for more information on prohibited words (www.companieshouse.gov.uk/about/gbhtml/gp1.shtml) or check with your company registration agent.
6 Other legal requirements
6.1 Find out if you need a licence. For example, running a nursing home requires a licence.
6.2 Check you have adequate insurance.
- Some insurance, such as employers’ liability, is compulsory even if you, the director, are the only employee.
6.3 Get advice from your accountant with regard to tax and VAT.
- You must register for VAT if your sales (‘taxable supplies’) in a 12-month period are more than £79,000 or are expected to exceed this limit in the next 30 days alone.
- Notify your Inspector of Taxes and the Department for Work and Pensions when you start trading.
6.4 Register with your PAYE tax office when you are likely to employ people.
- If you are paid a salary by your own company, you count as an employee subject to PAYE.
- Contact the New Employer Helpline (0300 200 3211).
7 7 A common pursuit
Many of the difficulties and disagreements arise over everyday policies and practices, rather than legal structure. You can avoid most of these problems by drawing up a comprehensive agreement on how the business should be run. Ideally, you need to discuss these issues with your partners and key employees.
7.1 Discuss what motivates you all.
- Why do you want to start a new business?
- What is the purpose of your business?
- Be frank about personal priorities — work, family, money, holidays, cars, travel.
7.2 Agree your business strategy and the short and long-term objectives you are working towards.
7.3 How will you manage the finances?
- How is the business going to be financed?
- How much will different partners contribute?
- How will profits (and losses) be shared?
7.4 Discuss responsibilities.
- Who will manage what?
- What is the decision-making process?
- How will you resolve disagreements?
7.5 Discuss day-to-day operations.
- How will you reward different individuals?
- What holidays are different people going to be entitled to?
- Will any friends or relatives be on the payroll?
7.6 Discuss ‘what if’ scenarios and write down your conclusions.
- What if you need to raise more money?
- How will you cope if one of the partners decides to leave the business?
- Do you have an exit plan?