If you will be the sole owner of the business, you can trade as a sole trader. You are self-employed, and there is no separate business entity. You can be a sole trader even if you have employees working for you.
Alternatively, you can form a limited company.
A limited company is a separate legal entity, distinct from its shareholders and directors. This makes it a flexible way of involving other people — for example, as investors, directors or employees. Forming a limited company is often advantageous if you plan to grow the business.
A limited company also offers you the protection of limited liability. This means that your risk of loss is normally limited to the money you invest in the business (as share capital or through a loan). To some extent, however, this benefit can prove illusory: if the business needs to raise further funds from a lender such as a bank, you are likely to be asked to provide a personal guarantee. You could also be held personally liable as a director if you allow the business to trade wrongfully – that is you carry on trading through it when you knew, or ought to have known, that there was no reasonable prospect of avoiding insolvency - or fraudulently.
On the downside, a limited company involves more administration and some costs. One option which suits some businesses is to start as a sole trader, and then form a company later on as the business grows, and transfer the business to it. In return, the company issues you with shares in itself, as ‘payment’ for the business.
Separately, you also need to think about the tax implications. Company profits, and any income you (or other employees) take from the company, are taxed differently from income as a self-employed sole trader (or from trading in partnership). The most tax effective business form will depend on how profitable your business is, and whether you will be reinvesting profits in the business or taking them for your personal use.
In an ordinary partnership, there is no limited liability: each partner is liable for the business debts of the partnership. This can help ensure that the partners are committed to the business — but equally, it can be personally disastrous if the business fails.
Separately, partners in a partnership pay income tax (and National Insurance contributions) on their share of the profits. Depending on how profitable the business is, and whether the partners want to reinvest in the business, this may be more or less tax-efficient than trading as a limited company.
In some cases, trading as a partnership is an attractive way for two or more people to form a business, particularly if the business risks are relatively low. But as the business grows, it is often a good idea to form a company: for increased flexibility, and to take advantage of limited liability. The main exception is in (the very few) businesses where you are required by law or, sometimes, the rules of your professional body or association, to trade as a partnership. In these cases, it is often advantageous to form a limited liability partnership.
If you are required to trade as a partnership, but are concerned about potential liabilities, then it may well be worth setting up a limited liability partnership (LLP).
Like a limited company, these are separate legal entities, distinct from their members. They have to be registered at Companies House and file accounts and an annual return every year but, in return, members enjoy the protection of limited liability. This means that your risk of loss is normally limited to the money you invest in the business (as loan capital). They are not as flexible as limited companies — it is difficult, for example, to bring in an outside investor who is not to be involved in daily management. As a member, you are taxed as if you are a partner in an ordinary partnership.
If you are not required to trade as a partnership, forming a limited company instead may well be a more satisfactory solution.
You do not need to form a separate business entity to start in business as a sole trader. You are required to advise HM Revenue & Customs, and will need to choose a business name (see 15). If you have been receiving any benefits, you will also need to notify your Job Centre. If you have been unemployed for some time, you may qualify for funding or assistance to help you set up your new enterprise.
Depending on your circumstances, there may be other legal issues that should be dealt with at this time (see 20).
If you start a business on your own, or with someone else, without forming a company, you will be trading as a sole trader or in partnership whether you intended this or not. You are legally required to notify HM Revenue & Customs when you do this and are likely to face a fine for failing to do so.
As you have not formed a company, you will be personally liable for any business debts.
If you are in business with someone else and are legally seen to have formed a partnership — even if you had no intention of doing so — you could be liable for your partners’ business debts. You also miss the opportunity to draw up a partnership agreement to suit your wishes (see 13 and 14).
The easiest way is to ask your legal advisor to handle it for you. You will need to choose a name which is not already being used (see 15). You will also need to provide details of the members (shareholders), directors and, if the company is to have one – it is optional for a private company - a company secretary (see 8).
You need advice if you want to include special terms to suit your circumstances in your company’s articles of association, or a shareholders’ agreement (see 11).
Every private company must have at least one director.
Private companies do not need to have a company secretary – the officer who normally takes responsibility for administering the company. However, all the administration tasks still have to be carried out, so most companies continue to have one. The company secretary can be a director as well but doesn’t have to be.
You should only ever buy a company from a professional adviser, or a reputable agent that they recommend to you. Otherwise you may find that the paperwork is improperly prepared. In the worst case, you could find that your company has existing liabilities of which you are not aware.
You should also be careful about the company’s name. You could face legal problems if your name is similar to a name used by another firm in a similar line of business (see 15).
The articles of association set out the rules of the company: for example, what powers the directors have, and how shares can be transferred.
You may want the articles to be as flexible as possible in many areas: for example, allowing the company to borrow money if the directors choose, and so on.
However, you may also want some restrictions. For example, the founders of smaller, private companies often include restrictions on the transfer of shares, aiming to retain control of the business.
You should discuss your requirements with your advisor. You should also discuss whether any special terms are best dealt with in the company’s articles or through a shareholders’ agreement (see 11).
There is no legal requirement to have a shareholders’ agreement, but it’s almost always a good idea if you will not be the only shareholder in the company.
Preparing a shareholders’ agreement gives you the chance to discuss and agree key issues: for example, what the strategy will be, what will happen if the business needs extra funding, what will happen if you wish to leave the company, and so on.
Although some issues can be dealt with through the company’s articles, a shareholders’ agreement may be a more effective method. Discuss your requirements with your advisor.
If you want to start trading in partnership, you are legally required to notify HM Revenue & Customs. You will also need to decide whether you will trade under the names of the partners, or use a separate business name (see 16).
Although you are not legally required to have a partnership agreement, failing to draw one up can have very unwelcome consequences (see 14).
If you want to set up a limited liability partnership, the process is more complicated. Take advice.
As a minimum, the partnership agreement should include:
You should use the preparation of the agreement as an opportunity to discuss broader issues, such as what your business strategy will be. You should also agree details such as holiday entitlements, whether you will employ members of your families, and so on.
Failing to prepare a partnership agreement increases the likelihood of disputes between the partners, and can make it more difficult to resolve them.
Also, if you fail to prepare an agreement, then it will be assumed that all partners are equal. They will have an equal role in decision-making and be entitled to equal profit shares. If this is not your intention, you must have an agreement.
As a matter of good business, you will want a name that is useful to you. For example, you might want a name that conveys the right image, tells potential customers what you offer, or that is memorable so that it easy for potential customers to find you online.
Legally, you need to ensure that your name is distinct from other firms in the same line of business. If your name misleads customers or potential customers into thinking they are dealing with another firm, you could be accused of ‘passing off’, and end up involved in a costly court action. You need to ensure that your name is not only distinct from companies’ names, but also any trading names or registered trade marks.
It’s a good idea to check the Companies House index of companies, and search the Trade Marks Registry. It’s also worthwhile checking whether internet domain names using your proposed name are already being used by another business.
There are also some restrictions on the words you can use (see 17).
Note that if you are forming a company, it is convenient if the company has the chosen name. But the company can trade under a different business name (see 16).
A sole trader can trade under his or her own name, or a business name. A partnership can trade under the names of all the partners, or a business name. A company can trade under its registered name, or use an alternative business name.
However, if you use an alternative name, you must disclose the ownership and official address of the business on your business stationery, on your website and at your business premises, and if anyone asks.
You cannot use a misleading name that might cause customers or potential customers to confuse you with another firm in the same line of business (see 15). For example, Companies House will refuse to register a proposed company name that is identical to that of an existing company (and words and symbols such as @ and ‘uk’ are ignored when considering whether a proposed name is identical to an existing one).
If your name is merely similar to an existing company it can be registered, but Companies House may direct you to change it to another non-similar name (provided it does so within 12 months of your registration), if it decides your name is ‘too like’ the name of the other company. It usually does this because the other company objects to your registration - but it is allowed to make a direction off its own accord if it wishes.
You cannot use words – often called ‘sensitive’ words - that imply a certain eminence or status without providing justification to Companies House. For example:
You can see a list of words that have to be justified, and how you justify them, at Companies House (although the rules apply to all business names, not just the registered names of limited companies).
There are also rules that stop you using anything other than Roman capital letters, numbers, common punctuation and certain symbols such as +, * and % &, etc (except in the first three characters of the name). You cannot use lower font, accents (or other marks like umlauts) or amalgamated letters that form a new character.
Sole traders (and ordinary partnerships) are prohibited from using the word ‘Limited’ (or Ltd) in their name, while companies are normally required to include the word at the end of their name.
A company’s business stationery, including electronic equivalents such as electronic order forms, invoices and your website, must include the company’s full name, place of registration, registered company number and registered office address. This applies even if you trade under a different business name. You do not have to show the names of the directors. However, if you choose to include the name of any of the directors, you must include the names of all the directors.
If you are a sole trader, your business stationery must include your name, any business name you trade under, and a business address.
If you are a partnership, your stationery must include the names of all the partners and your principal business address. (If there are more than 20 partners, the stationery can instead state that a list of partners can be inspected at that address).
In all cases, if you are registered for VAT, any invoices must also carry your VAT number.
If your business is regulated — for example, if you are an accountant, solicitor or financial intermediary — your stationery may also be required to carry additional regulatory statements.
You must have signs showing any trading name and details of the business ownership — the requirements are the same as for your stationery (see 18). Business premises include any premises from which you carry on business (except for an address that is primarily living accommodation) and, if you are a limited company, your registered office address (even if it’s only an accommodation address or the place where you live) and any address (other than your registered office) where you keep your statutory registers or any other records required under the Companies Act (called a ‘single alternative inspection place’ or SAIL in the rules).
There is an exemption from all these rules if your company has always been dormant – nothing has gone through its books – and there are special rules if the company becomes insolvent.
Various legal issues often arise when you start a business. For example:
Talking through your plans with an experienced adviser will help you identify the major areas to address.