What Legal Structure Should Your Business Choose?

Shaun Balderson is a Content Writer at Company Formations 24.7, a top UK company formation agent.

One of the most important decisions that you will make as a startup is choosing a legal structure for your company. It will create the foundations of your business, so read on for a couple of short and simple summaries explaining what each one means.

Sole trader

As a sole trader, you run your own business as an individual. However, despite the often misleading name, you can employ staff. 'Sole trader' simply means that you and your business are the same thing. Sole traders are the only legal structure that doesn't need to be registered at Companies House, but you must fill in all the required paperwork for HMRC.

Advantages

  • Profit: You can keep all your business' profits after you've paid tax.

Disadvantages

  • Liability: You can be held personally responsible for any and all of your business losses, even to the point that you may be forced to sell your personal assets.
  • Tax: You have to pay income tax on the profits your business makes, not corporation tax.

Company Limited by Share

In a limited company, the liability of members in the company is 'limited' up to the value of their shares in the company.

Requirements

  • At least one director and one shareholder. The shareholder and the director can be the same person.
  • The company name must have the suffix 'Limited' or 'LTD'.

Advantages

  • Limited liability: The company is liable, not you, for any losses and the liability of the shareholder is capped to the amount paid on the shares that they have subscribed to.
  • Taxation: They are taxed under corporation tax.
  • Status: Trading under a limited company provides an element of status that cultivates a greater level of trust from the public. 
  • Protected trading name: The name of every Limited Company must be unique and there are rules regarding trading names. For more information on trading names, check out these two articles on restrictions and sensitive words or expressions

Disadvantages

  • Transparency: The company is required to disclose certain information. When you incorporate a Limited Company you must provide Companies House with information on all officers, directors, people of significant control and shareholders. Additionally each year you must provide an Annual Confirmation Statement as well as Annual Accounts declaring your company’s finances.
  • Administrative burden: There are a few administrative hurdles to jump. You will have to undergo certain procedures for different situations and also retain certain information in your Statutory Registers. This is outlined in the Articles of Association and Companies Act 2006. 
  • Accountancy fees: Accountancy fees are generally a little more expensive for Limited Companies as the accounts are slightly more complicated.

Company Limited by Guarantee

Companies Limited by Guarantee are companies that do not have a share capital but still benefit from limited liability. The members of a Company Limited by Guarantee are known as 'Guarantors'. Their liability is limited to a nominal amount specified in the Articles of Association that they each guarantee to contribute to the debts of the company in the event that it is wound up. This structure is primarily used for social enterprises, charities and sports clubs.

Requirements

  • At least one director and one guarantor.

Advantages

  • Limited liability: The same benefits of a company limited by shares apply to a company limited by guarantee.
  • Suffix exemption: The company can be exempt from using the word 'Limited' in its name. This occurs when the aim and objectives of the company surround the promotion of the arts, sciences, education and charity. Not having the word 'Limited' in your company name is a quick indicator that the company is formed for public benefit and not for the benefit of its members.

Disadvantages

  • Transparency, administrative burdens and accountancy fees: A company limited by guarantee has the same disadvantages as a company limited by shares.

Limited Liability Partnership (LLP)

Limited Liability Partnerships (LLPs) offer the individuals who own the entity all the benefits of operating as a partnership but with protection of limited liability. The LLP is not taxed under corporation tax, but the members are taxed income tax on their entire proportion of income from the LLP. This structure is popular amongst firms of solicitors, architects and accountants.

Requirements

  • At least 2 designated members.
  • The company name must have the suffix 'LLP' or 'Limited Liability Partnership'.

Advantages

  • Limited liability: You gain all the same benefits as a company limited by shares.
  • Flexibility and partnerships: An LLP provides the flexibility and benefits obtained within a partnership.

Disadvantages

  • Transparency, administrative burdens and accountancy fees: A LLP is hindered by the same issues that a company limited by shares has. 
  • Organisational burden: At least 2 of the Partners of the LLP must be 'Designated Members'. Designated Members are the ones who bear the responsibility for meeting the statutory requirements of the LLP.

Community Interest Companies (CIC)

Community Interest Companies (CICs) are a special type of limited company designed for social enterprises that want to use their profits and assets for the public benefit. CICs are easy to set up and have all the flexibility and certainty of limited liability companies but with some extra features, such as the asset lock, to ensure that their profits can only be used to further their objects.

Requirements

  • CICs must be limited companies of one form or another.
  • A CIC cannot be a charity or political group.
  • When you apply through Companies House you must include a 'community interest statement'. 

Advantages

  • Less admin and regulation than a charity: There is less admin necessary to set up and run CICs than a charity. There are also fewer restrictions on trading activities. 
  • You can participate in the earnings: as a director you may be paid a salary and as a shareholder you may receive a dividend, though the dividend will be subject to an upper limit.

Disadvantages

  • Administrative and regulation burden: CICs have more restrictions on activities than a normal company. One being that you must work within a specified community defined in your community interest statement. You also must submit annual community interest reports.
  • Shareholders benefits are limited: As assets and profits may only be used for the benefit of the CIC and its community, shareholders are restricted in the amount of dividend they can take. As a part of the asset lock, assets can only be transferred at full market value to another asset-locked organisation.
  • Less funding available: Despite a growth in available investment for CICs in recent years, funding can be scarce, particularly for CICs limited by shares.

As a startup, this article provides an overview of the main company structures that are available for you to choose from. There are also PLCs, but these are costly legal structures and should only be approached after consulting a professional advisor or your accountant.