Choosing the right business structure in the UK

Choosing a legal structure is one of the first decisions you make when setting up a business or reorganising it. It affects who owns the business, who is liable for its debts, how decisions are taken, what records you must keep and how profits are taxed. A structure that is appropriate for a one-person consultancy may be unsuitable for a business with multiple founders, external investors or international operations.

There is no single right answer. The best option depends on the commercial model, the people involved, the level of risk, the funding plan and the expected direction of the business. It is therefore worth considering the legal implications before registering a business or signing any agreements with co-founders.

Sole trader or limited company?

A sole trader runs a business as an individual, rather than through a separate company. This can suit freelancers, independent consultants and small businesses that want a simple structure. A sole trader does not incorporate a company at Companies House, but must generally register with HMRC for Self Assessment and keep business records.

The key legal point is that the individual and the business are not separate legal persons. The owner is generally personally liable for the business's debts, including sums owed to a supplier, a landlord or a lender. Business insurance and good contracts can help to reduce some of the risks, but they do not create limited liability. A limited company, by contrast, is a separate legal person whose shareholders generally have limited liability.

A sole trader may later incorporate a company, but transferring the business can involve contracts, assets, employees, tax and third-party consents. It should be a planned transition rather than an administrative change.

Ordinary partnership: shared business, shared liability

A partnership exists where two or more people carry on a business in common with a view to profit. An ordinary partnership in England and Wales has no separate legal personality. It may be the right structure for people who wish to go into business together without setting up a company.

However, each partner can generally bind the firm and the other partners when acting in the ordinary course of its business, and the partners are personally liable for the firm's debts and obligations.

A partnership agreement is important even where the partners have known each other for a long time. It should cover capital contributions, profit sharing, decision-making, drawings, duties, retirement, expulsion, death, incapacity and dissolution. Where the partners have not agreed a matter, the default rules in the Partnership Act 1890 will generally apply.

LLP vs limited company

An LLP is a separate legal entity registered at Companies House. It must have at least two members, and at least two of them must be designated members. It combines the internal flexibility of a partnership with limited liability for its members, although that protection is subject to exceptions similar to those that apply to companies (see below). It is commonly used by professional firms and other businesses whose members want that flexibility.

An LLP has filing and governance requirements, including annual accounts and confirmation statements. Its members should have an LLP agreement covering management, contributions, profit sharing, transfers and the effect of a member leaving.

The main differences from a company are control and tax. A company distinguishes between shareholders and directors, while the members of an LLP determine how it is run through their LLP agreement. Tax treatment also differs (see Tax and investment implications below). Tax advice should therefore be taken before choosing between them.

Private limited company

A private company limited by shares is a separate legal person. The shareholders own the shares and the directors run the business in accordance with the Companies Act 2006, the articles and other legal obligations.

A shareholder's liability is ordinarily limited to the amount, if any, unpaid on their shares. That protection is not absolute. Personal guarantees, director misconduct and certain statutory liabilities can all expose individuals to personal liability.

A company is often appropriate where a business intends to employ people, retain profits, bring in investors or have a clear ownership structure. It is also subject to more formal administration, including statutory records, accounts, confirmation statements, records of directors' decisions and tax returns. The company's money and assets belong to the company, not to its directors or shareholders.

Ownership and control are not the same thing

A frequent point of confusion is the difference between shareholders and directors. Shareholders own the shares and hold the rights attached to them, which usually include the right to vote. Directors run the company and owe it legal duties. In a small company, one person can be both sole shareholder and sole director, but the two roles remain legally distinct.

Where several people are involved, the articles of association and a shareholders' agreement can set out how control works. Reserved matters, board structure, share transfers, pre-emption rights, deadlock and exit arrangements should be considered at the outset.

Tax and investment implications

Tax should inform the decision, but should not be the only factor. A sole trader is normally taxed on the business's profits through Self Assessment, while a partner is normally taxed on their share of the firm's profits. A company is normally subject to Corporation Tax on its taxable profits, and payments to shareholders or directors have separate tax consequences.

An LLP carrying on a trade or business with a view to profit is normally treated as transparent for tax purposes, so its members are taxed on their share of the profits. The exact position depends on the members and the activities, and some members may be treated as employees under the salaried member rules.

Investors may prefer a company with defined share classes and governance documents. Lenders and commercial counterparties may ask for personal guarantees, security or evidence of authority. Limited liability may offer little practical protection if the founders have signed personal guarantees.

International and regulated businesses

Where the owners, staff, customers or management are in different countries, consider where the business is effectively managed, where it has a taxable presence and which law will govern the key contracts. Founders of a UK company who live abroad may also need advice in their country of residence. See our guide to starting a business in the UK as an international founder.

A regulated activity may require a particular type of entity, a licence or ownership approval.

Questions to ask before you choose

Before you choose a structure, ask:

• Who will own the business?
• Who will make the decisions?
• What are the financial risks?
• Will external investment be needed?
• Where will the business operate?
• What happens if an owner wants to leave?

The answers will help to narrow the options and identify the documents you need.

Scornik Gerstein LLP advises entrepreneurs and businesses on company formation, corporate structuring and commercial contracts. Taking advice before trading starts can help to align the legal structure with the commercial plan and reduce the risk of later disputes between the owners.

If you are choosing a structure for a new or existing business, our corporate and commercial team can help you compare the options and prepare the documents you need. Contact us to discuss your plans.