When you have decided that becoming self employed or starting up a business is definitely for you, there are certain choices you have to make about the way you set the business up. The choices you make can affect the business in several ways, so it’s worth taking the time to make the right choice.
The four main choices for the legal status of your business are:
Sole Trader
This is the simplest form of trading and the one adopted by many small start-up businesses. You simply need to register as self employed with HM Revenue & Customs (HMRC) as soon as possible and in any event within three months of becoming self-employed. You are solely responsible for the business and keep all the profits. Your profits are taxed as income, you pay class 2 and 4 National Insurance contributions and you have to produce an annual self-assessment tax return.
Disadvantages of being a Sole Trader:
- As a Sole Trader, you are personally liable for all your business debts you accrue, which means that all of your assets (including your home) could be at risk if your business fails.
- You cannot claim as many social security benefits
- It will be a lot harder to raise finance for the business
- It is harder to sell the business on if you a Sole Trader
Partnership
A partnership is another relatively simple way to set up a business, but there are two or more people involved instead of one. The partners usually share the profits and each partner takes responsibility for decision making and running the business. The process of setting up a partnership is very similar to that of a Sole Trader, but it is normally recommended to get a comprehensive partnership agreement drawn up by a lawyer to avoid disputes.
Disadvantages of a partnership:
- Each partner is personally liable for all the business debts, even if they were caused by the other partner
Limited Company
A limited company exists in its own right and therefore you are only liable for the amount you have invested in the company (although with a new company you will often be asked to give personal guarantees). Forming a limited company involves paying a fee (normally between £100 - £500) and registering with Companies House (www.companieshouse.gov.uk). Limited companies are generally considered to have more credibility than sole traders or partnerships and it is easier to raise finance. There can also be tax advantages for high earners.
Disadvantages of a limited company
- Initial set up costs of several hundred pounds
- You have to file annual accounts with companies house and the accounts are generally more complicated
- National Insurance payments are higher
- It can be more difficult to wind up a company if you stop trading at any point
Limited Liability Partnerships
A limited liability partnership is similar to an ordinary partnership in some ways, but liability is limited to the amount that each partner has invested in the business. It is taxed as a partnership and annual accounts must be filed.
Disadvantages of limited liability partnerships
- Members must make individual tax returns and the limited liability partnership itself must file annual accounts with Companies House