We get frequent enquiries asking how to structure a new business and the answer obviously varies quite a bit depending on many factors including:
- Business or ‘investment’ activity
- Whether there will be research and development expenses
- The age of the owner and whether they are looking to undertake estate planning
- The longer-term intention for the business i.e. to grow and sell, for income stream or both
- Whether there are multiple partners
- If incentivising key employees is desired
- Whether there are overseas elements to the business
- What the risks are
- Whether the ultimate owner(s) are non-UK domiciled
- If receiving investment, where that is coming from
Ways To Structure A New Business:
Most of the time, it is likely a limited company will be the right way forward although how that is structured will again depend on factors like the ones above. Those factors can affect the share classes, the articles, how investment is structured and, of course, shareholder agreements. Where there are offshore elements to the business such as the owners being non-UK domiciled or investors structuring their investment from offshore the ultimate structure could involve offshore holding/investing structures.
The reasons a limited company will often be the sensible vehicle to use are:
- Liability is limited to the shareholders capital unless personal guarantees are given
- A company may receive tax favoured treatment for research and development expenses
- Estate planning is often easier with shareholdings rather than the whole business or underlying assets
- Multiple partners simply become shareholders with shareholders rights governed by the shareholder agreement
- Key employees can be incentivised through an enterprise management incentive share scheme
- Investment can be structured in more ways: shares of a particular class, preference shares, convertible securities/stock, or just a loan
However, with a limited company there is an increased level of administration and formality. You will need a company secretary and registered office. There are filing requirements at Companies House for numerous acts and failure to file on time results in penalties. Also, the directors of a company should meet, hold a board meeting and record the decision of the board. This is good corporate governance but often forgotten by smaller companies and decisions are made without recording them. If the company is being developed for an eventual sale, good corporate governance is important. If a limited company is right for your business, it is possible you will need a professional to assist with compliance and governance.
A limited company pays lower tax than an individual and therefore they may be seen as good vehicles for stockpiling cash or investments. However, if those investments become large, the company will not be a trading company for capital gains tax purposes and the favourable CGT rates may be denied on an eventual sale.
The advantages of being a sole trader is its simplicity – it’s just you performing a business trade. There are no costs to setting up as a sole trader and there is little additional compliance – there is of course tax compliance! It’s one of the easiest ways to structure a new business.
The main disadvantage is that the law does not seperate the business and its owner: liability is unlimited. This means that if you hold personal assets and the business incurs debt, the creditors may claim against you personally. The trade also ceases in the event of your death or retirement unless sold or passed on beforehand.
A sole trader does have to register for self-assessment with HMRC and complete an annual tax return. The tax position is not too dissimilar to receiving employment income although your profits are taxed as your income and therefore when profits excel, you have little ability to prevent higher rate taxes. A company pays corporation tax, which is lower than income tax and therefore so long as you don’t take funds out, the net tax position with a company may be less.
A partnership is more than one person coming together to undertake the business: it is like two or more sole traders holding hands and working together! Be warned where you end up working with someone informally – the 1890 Partnership Act can dictate your ‘partnership’ arrangement. The provisions of that Act are not good for informal partnerships and profit may be split equally regardless of capital introduced etc. It is always sensible to formalise your arrangements with partners, consultants, contractors and suppliers to avoid claims within this Act.
Your risks are not dissimilar to that of a sole trader although you do have the additional risks of the decisions and behaviour of the other partner(s). The tax position is not dissimilar to that of a sole trader. The partnership does however have to submit a partnership return also.
Limited Liability Partnerships (LLP)
The law giving rise to the LLP was introduced in 2001. They offer the limited liability available to limited company shareholders although are taxed as a partnership. The LLP must have at least two ‘designated members’ responsible for filing annual accounts. The number of members (partners) is not restricted. The LLP is governed by a members’ agreement which sets out the rules of operating along with decisions making as well as capital and profit share arrangements. Members’ liability is limited to their capital invested and any personal guarantees.
As with a partnership, the members’ share of profit is taxed as income. Each member will be required to register for self-assessment with HMRC and the LLP will have to make a partnership return.
LLPs are registered at Companies House and similar compliance is required as for a limited company.
Many larger professional service firms have formed LLPs. In addition, several arrangements were established with LLPs to allow business owners to vary how they received income i.e. by way of dividend of partnership share. Some of the historic tax planning implemented with LLPs permitted profit extraction through overdrawn capital accounts and or disposal of an interest subject to the favourable CGT rates. LLPs were also used to work around disguised remuneration rules. The use of LLPs in tax planning have therefore been the concern of the Treasury with targeted legislation being introduced.