What are the types of legal status you can choose? There are a number of different ways you can set up your business and each one has its advantages and disadvantages.

Sole Trader

A sole trader has complete control of how their business operates, makes all the decisions and has control of all the profit.

They can hire employees, but many sole traders wish to run the business on their own. They have the freedom and complete control to run the business, but may find they would like to share some of the responsibilities once the business grows. 

As a sole trader, you can start trading almost immediately, without too much initial investment in overheads. If your business is largely dependent simply on you and your skills, sole trader status could be the most appropriate option.

There are however, pros and cons to this choice:

Advantages

• Start-up formalities are minimal and costs are therefore low. You must register as self employed by contacting HMRC. If you think your turnover is going to reach the threshold that requires compulsory VAT registration in a 12-month period, you should also register for VAT immediately.
• No accounting or business audits are necessary. However you do need to complete an annual self-assessment form for tax, so you will need to keep accurate records of your income and expenses, as you pay tax at the personal rate on your net profits.
• Class 4 National Insurance Contributions (NICs) are payable as a percentage of your net profits, depending on the levels of profit achieved, as well as a fixed-rate Class 2 NICs.
• You have full autonomy of all business decisions, and all earnings from the business belong to you.

Disadvantages

• There is unlimited liability for debts, so if the business loses money, you may have to sell your personal assets (house, car, etc.) to pay off business debts. In extreme cases this could result in bankruptcy.
• It can be more challenging to obtain finance for your business from outside funders.
• Growth of the business may be limited as it relies on one person’s capacity to lead.
• Innovation may be restricted by your isolation from outside influences.
• As a sole trader you may be entitled to fewer social security benefits than an employee.

Partnerships

In a partnership, two or more people set up business together. They share all the risks, costs and responsibilities, as well as the profits.

Each partner needs to register as self-employed. As with a sole trader fixed-rate Class 2 NICs are payable, as well as Class 4 NICs on each partner’s share of the partnership profits.

There is no legal requirement to have a written partnership agreement. It is recommended however, that you take specialist advice and have one drawn up. The agreement will set out the basics such as what share of the profits the partners will take, their roles and responsibilities, and what will happen if one of the partners wish to leave.

Advantages

• The business is more likely to survive if one of the partners leaves, dies or becomes ill.
• Day-to-day management can become easier by the allocation of roles to specific partners.
• Greater success may be achieved by combining the talents of the partners, than could be achieved alone.
• More available capital to invest in the business may be available from two partners than from an individual working alone.
• Shared roles and responsibilities may make it easier to take time out from the business.

Disadvantages

• Like sole traders, partners have unlimited liability for business debts.
• Disagreements between partners can lead to dissolution of the partnership.
• Partnerships rely on trust and honesty – all partners are jointly liable for any debts incurred, so choose you partners wisely.
• Although there are no mandatory documents required (as per the sole trader), a partnership agreement is recommended, and you may need to take specialist advice to have one drawn up.
• The partnership has no legal existence of its own so if a partner resigns, dies or goes bankrupt, then the partnership can be dissolved

Limited Companies

When a limited company is set up, the business is treated as a separate legal entity from its owner, with its own legal existence. Crucially the company’s finances are separate and distinct from the personal finances of the owners.

If you are setting up a business that needs a lot of start-up capital, a Limited Company will give you more protection if the company fails. It may be more advantageous from a tax point of view depending on your personal circumstances and the level of earnings you expect to achieve from the business.

Shareholders in the business can be individuals (or other companies). They are not liable for the debts of the company unless they have given a personal guarantee, for example, bank loans, overdrafts etc. If the company is not successful they may well lose the money they have invested into it, but that is the extent of their liability.

Advantages

• Liability for debts is limited.
• The business is likely to have a longer lifespan as it is a separate legal entity from its owner. It may therefore be easier to sell it as an asset if you wish to pass it on at a later date.
• Ability to bring in new investment through issuing shares in the company.
• Directors control the business.
• The overall tax bill of the company may be lower. As a sole trader all profits are taxed at a personal rate. As a director, only the salary you pay yourself as an employee is taxed in this way (along with Class 1 NICs), but you may be able to take dividends out of the company profits. These payments may not attract National Insurance as wages do, although the company may have to pay employers NICs (subject to appropriate wage thresholds). The profits of the company are then taxed separately at corporation tax levels which may be at a lower rate than the personal tax rates of a sole trader.

Disadvantages

• The cost of administering the business are higher and set up is slightly more complicated than for other types of business.
• You will need to formally create the limited company with Companies House or you can buy an “off the shelf” company from a number of different sources on the internet.
• Accounting and audit requirements apply such as the obligation to submit annual accounts at Companies House.
  If you decide not to continue with the business, you will need to formally dissolve the company. You cannot just stop trading and close it without following the formal dissolution process.

Limited Liability Partnership

A Limited Liability Partnership (LLP) is a hybrid of a Partnership and a Limited Company. Unlike an ordinary partnership, each partner’s liability is limited to the amount of money they have invested in the business and the amount of personal guarantees they have given to raise finance.

At least two of the partners must be “designated members” which means they have extra responsibilities. LLPs must register at Companies House and have to file annual returns.

The profits of a member of a LLP remain taxable as a self-employed person and liable to Class 2 and Class 4 NICs.

Community Interest Company

Essentially, a CIC is a Limited company whose aim is for social enterprise. To set up the business must pass a community interest test and you must use your profits and assets to benefit the community and not just yourself or your employees.

More information at the Office of the Regulator of Community Interest Companies