There are many ways to operate a business. Going out into the business world may seem a simple matter. But the risks and liabilities that go along with these choices are key to understanding how your business will have to operate. All have their advantages and disadvantages so it is important to take a good look at all your options before setting out.
A sole trader is a one-person business, as a sole trader you may employ workers, but you have full control of the business and enjoy all the profits (after you have paid tax on them).
Sole traders do not have a separate legal existence from their owner. There is no legal difference between the business and the owner, the owner faces unlimited liability and so will bear all the risk and be personally liable for the firm's debts. These debts might have to be paid out of your own pocket. So whilst you have the benefit of complete control, if the business suffers your personal wealth could too.
As a sole trader you have to register with HM revenue customs as soon as possible. You could face a large penalty if this is done later than 5 October of your business’s second tax year. Also if you think your business takings may exceed £79,000 a year, you will also need to register for VAT.
Partnerships are businesses owned by two to twenty people (there is a maximum of 10 partners if your business is in the banking sector). The profits and debts are shared between all partners. The rights and responsibilities of each partner are drawn up in a ‘deed of partnership’. This deed sets out how much each partner has contributed and how the business’s profits and losses will be shared. Common examples of partnerships are doctors, dentists and law firms.
Like a sole trader, partners have unlimited liability. But the advantage over a sole trader is that this responsibility is shared between partners. A partnership can also have a ‘sleeping partner’ who invests in the business but does not have dealings in the day to day running of the enterprise This is a good way of raising capital if needed, given you cannot sell shares in partnership.
Partnerships are formed under a contract; this can be written or oral. Unlike a limited company you do not need to register with a public body.
But nominated partners must register with HMRC and be responsible for keeping business records and managing tax returns. Similar to a sole trader you must register with HM Revenue & Customs (HMRC) as soon as possible after setting-up the business. If you think your business’s takings may exceed £79,000 a year; you will also need to register for VAT.
If you do not want to be held responsible for the debt you can set up a limited liability partnership or limited company.
A limited liability partnership is a hybrid of partnership and limited company. Similar to a limited company, ‘limited’ partners are not personally liable for debts the business cannot pay, but there must be at least one ‘general’ partner who will still be liable for the partnership's debts. The limited partners only have limited rights and can only give general business advice. Any involvement in management areas means you will have the usual unlimited liability for all partnership assets.
Unlike an ordinary partnership, an LLP must be registered with the registrar of companies before it can start trading. An application must be completed and signed by all the partners, along with the £20 fee (or £100 same-day registration service). There is a standardised LP5 form available on the Companies House website which must be used.
The ownership of a limited company is divided up into equal parts called shares, these shareholders are effectively the owners of the company but unlike a sole trader or a partnership, the owners of a limited company are not necessarily involved in running the business, unless they have been elected to the Board of Directors.
There are two main types of limited companies:
Limited companies have their own legal identity, so unlike a sole trader or partnership the business has a separate legal identity from the owners.
Because limited companies have their own legal identity their owners are not personally liable for the firm's debts. Each shareholder has limited liability for the company’s debts. This means they will only lose their investment in the company if it goes bust. As well as this, as a director you would not be personally liable for any debts, which is a major advantage.
There are a number of legal documents that have to be completed in order to get up and running. To be able to trade as a private limited company you need a Certificate of Incorporation from the registrar of companies. To obtain this you need to submit a Memorandum of Association and Articles of Association. These cover details such as the objectives of the business, the company’s rules, the address of the registered office and the capital raised from the shares sold.
Four other key areas to consider are:
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