Understanding different business structures in the UK and which is right for you?

When starting a business in the UK, one of the first decisions you will need to make is what type of legal structure your business will take. There are several options available, each with its own unique benefits and drawbacks. 

In this blog, we will explore the four main business structures in the UK, notably sole trader, limited company (Ltd), partnership and limited liability partnership (LLP). Although there are other legal business structures available, such as offshore companies and community interest companies, the majority of businesses will start out as one of the four mentioned earlier.

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Sole trader

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As a sole trader, you run your own business as an individual. This is the simplest and most straightforward business structure. It requires less administration and more privacy because you don’t need to register with Companies House. For the purposes of taxation, you are treated as self-employed, therefore, you will not be subject to UK corporation tax (CT) but you will need to register with HMRC for self assessment and complete a self assessment tax return.

This is a great choice for those venturing into the world of entrepreneurship, pursuing their passion, or working in service-based professions, such as freelance marketers, plumbers, consultants and contractors. Sole traders can also have employees but will need to register as an employer with HMRC and submit a PAYE registration form. When hiring, it is important to be aware of the difference between hiring a freelancer, consultant or contractor as they carry different employer responsibilities. A significant downside of being a sole trader is that you are personally responsible for all the debt within the business, which can have serious repercussions.

From a legal perspective, the sole trader and their business are one entity, whereas if that individual sets up a limited company (Ltd) then the company becomes a separate legal entity in its own right, even if it only has one owner. By being treated as one entity, sole traders may put their personal assets at risk if something were to happen to the business that would result in insolvency. On the other hand, the legal separation of the limited company from the individual director means that the company is responsible for its own debts and not the individual director. We will be discussing limited liability companies in the article below. 

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Limited company (Ltd) 

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One of the most popular legal structures for all types of businesses in the UK are limited companies. The owners of the business are legally responsible for its debts up to the amount of capital they invested. In other words, the liability of the shareholders, in the event of business insolvency, is limited to their investment. There is no minimum capital requirement in the UK, so in many cases the amount at risk will be £1, or £100. This structure is beneficial for those looking to protect their personal assets should the business fail or incur substantial debts. 

To proceed with a limited company, you would need to appoint a director and at least one shareholder (although you can be both). It’s worth noting that every year, you will need to submit your annual Confirmation Statement, this confirms that your company details at Companies House are up to date and it costs £13 to do it online.

Limited companies have an advantage in terms of tax efficiency and the potential to pay lower tax than a sole trader. At the time of writing, the main rate of corporation tax will be 25% for companies with profits of £250,000 or more. However, companies with profits of £50,000 or less will pay the small profits rate of 19%. Companies with taxable profits in between those numbers will pay a marginal tax rate of 26.5% on profits above £50,000. Additionally, limited companies may qualify for a wide range of allowances and tax-deductible expenses. On the other hand, sole traders pay between 29-47% on the profits of their business through income tax and national insurance. 

Operating as a limited company can also appear more professional, which can boost your business’s credibility with customers and potential investors. However, with this comes the need for more paperwork, which brings us to some of the disadvantages of operating as a limited company.

There is less privacy involved when setting up a limited company. You would need to register your business with Companies House and are responsible for filing annual accounts with Companies House all of which can be accessed by anyone as they are part of the public record. This level of transparency might not suit everyone, especially those preferring a simpler, less administrative-intense business model. The documentation to Companies House is in addition to any tax returns that need to be filed to HMRC. 

‍Partnership

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A partnership is a simple business structure involving two or more individuals who agree to share ownership, profits, assets and liabilities of a business. It is relatively simple to set up. To register your partnership, you will need to name a nominated partner and to complete form SA400 which registers your partnership for self assessment. Afterwards, each individual that will become a partner needs to complete SA401 form that registers them for self assessment and class 2 NICs.

Although not legally required, when setting up a partnership, we strongly recommend having a partnership agreement that can be used in future situations where dispute resolution is required. Not having your own partnership agreement will automatically mean that your partnership will be governed by the Partnership Act 1890, which may not be your intention.

Similar to a sole trader, there is little distinction between the partners and the business, therefore each partner is personally liable for the business debts, without any limit. This is an important consideration as you may be financially responsible for a decision made by other partners and vice versa. Equally though, you are able to benefit from mutual support and camaraderie when operating as a partnership because each person has a stake in the success of the business.

Both sole traders and partners pay tax on the profits through self assessment and do not need to complete a corporation tax return like in the case of a limited company. Although there’s less paperwork and financial documentation compared to a limited company, record keeping of income and expenses is still required. When operating as a partnership, each partner will need to file their own self assessment tax return including details of their profits and any other necessary information, which would need to be accurately apportioned. 

Partnership businesses benefit from a similar level of privacy as the sole traders, such as not needing to register with Companies House and file annual accounts meaning that there is no documentation in the public registry.

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Limited liability partnership (LLP)

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A limited liability partnership (LLP) is an alternative structure where partners have limited liability, i.e., they are only liable for the amount they have invested in the business, protecting their personal assets from the business’ debts. LLPs are required to register with Companies House, maintain detailed financial records, and file annual financial reports, similar to a limited company. However, you and anyone else working with you will be paid through self assessment rather than PAYE, which would have been the case for a limited company.

LLP taxes are paid not based on corporation tax but rather each partner pays personal tax on their profit share through a self assessment tax return. The profit share model encourages partners to contribute their best efforts, as their personal financial gains directly correspond to the overall profitability of the business. This structure can foster a deeper sense of responsibility and commitment among partners, leading to enhanced strategic decision-making, innovation and overall business growth. It is worth noting that profit sharing agreements must be clearly defined and outlined in the LLP agreement for transparency and to prevent any potential disputes.

LLPs combine the flexibility and comradery of partnerships with a limited liability of companies. Although this structure is most popular among professional service firms such as solicitors, architects and accountants, there is no restriction to the sectors that are eligible to trade as LLPs. 

A traditional partnership could suit small businesses or freelancers or a group of business friends who value simplicity and are comfortable with shared liability. In contrast, an LLP may be more appropriate for a larger, more established business or those in professional services, where the protection of limited liability is highly valuable but you want the people you work with to have a stake in the business. 

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To summarise 

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In conclusion, the business structure you choose will significantly impact various aspects of your business, including liability, control and taxation. In the UK, sole tradership offers simplicity and complete control, yet comes with unlimited personal liability. A traditional partnership shares many of these characteristics but adds the dimension of shared control and responsibility. A limited liability partnership offers limited liability protection while maintaining the flexibility of a partnership, ideal for larger businesses in professional services. Finally, a limited company provides the most robust protection against personal liability, along with certain tax benefits. However, it requires rigorous financial reporting and governance.

Each structure has its distinctive features, advantages and disadvantages, therefore you should carefully consider your business model, long-term objectives, and risk tolerance before making a decision.

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