Which Structure is Best for My Business in England or Wales?

If you are a business owner or interested in starting a business, it is important to know how to structure your business for maximum benefit. For instance, you might want to limit your personal liability or raise outside investments. Notably, there are many business structures to choose from.

This article will explore:

• the four main types of business structures;
• their advantages and disadvantages; and 
• the difference between incorporated and unincorporated businesses.

Unincorporated vs Incorporated Businesses

The most basic distinction between different business organisations is whether they are incorporated or unincorporated.

The two unincorporated business structures we will look at are:

• sole traders; and
• partnerships.

The two incorporated businesses we will look at are:

• private limited companies; and
• limited liability partnerships.

Unincorporated Businesses

Unincorporated businesses do not require any formal steps to come into existence. They automatically arise whether you intend for them to or not. This can be advantageous because there are no formalities or paperwork necessary. You just start trading.

The most important legal distinction you should be aware of when it comes to an unincorporated business is that it does not have a separate legal existence from its owner(s). 

An Example

Suppose that you have a work van, which you only use for work. You have a home, which belongs to you and your husband. You have recently received £20,000 worth of building materials from a supplier for a construction job you are running and use them for a job. However, you have not received payment from your client. You also owe a mortgage on your house.  

You might keep them separate, for example, when balancing your books:

But in fact, the law sees it as: 

The effect is that there is nothing between your business’ assets and liabilities and your personal assets and liabilities. Hence, if you injure someone during your trade and you are sued, except for any insurance policy, you could lose your house to cover a liability you incurred through your business.

Sole Traders

This is the most common kind of unincorporated business in the UK, with more than 3.5 million active sole traders. You could be selling luxury watches, cutting hair, or babysitting, and unless you have taken other steps, you are automatically carrying on as a sole trader.

Partnerships

When two or more people operate some enterprise with a common view to make a profit, a partnership will arise automatically. There are over 45,000 such partnerships in the UK, sometimes called “ordinary partnerships” or “unincorporated partnerships.”

The Partnership Act governs partnerships. This legislation is vital to note because unless there is an express agreement (written or oral) containing the terms of the partnership — which is to say, the duties one partner owes the rest and vice versa — the actual terms of the partnership will be implied by the Partnership Act.

Since the legislation is over 130 years old, many implied terms are outdated and unusual. As one example, if you want to remove a partner, you will need the consent of every partner in the partnership, including the one you want to remove.

Additionally, unincorporated partnerships cannot own assets in the partnership’s name. Practically, any sort of asset like an office or piece of machinery you want to use to make a profit will be purchased in your partners’ names and be held “on trust” for the other partners.

Liability in a Partnership

Like sole traders, each partner has unlimited liability for any debts or obligations the partnership incurs because the partnership is not incorporated. Moreover, each partner is liable for any debts any other partner incurs.

Therefore, if you think you are operating some sort of enterprise with another person, at the very least, you ought to try and both agree to a formal partnership agreement. You can complete this agreement through a simple contract signed by each partner. 

Incorporated Businesses

The concept of the incorporated business, in particular the limited company, and the English incorporated company, exist as “separate legal persons”. This means that if your company is incorporated, it can:

• enter into its own agreements;
• own its own assets;
• assume its own liabilities; and 
• sue and be sued.

In most cases, those who own the company and those acting on behalf of the company will not assume liability for its debts, though they will share in its profits.  

The two incorporated businesses we will look at are:

• private limited companies; and
• limited liability partnerships.

Private Limited Companies

Compare private companies to public companies, which are companies whose shares can be sold to the public. In practice, most companies start as private companies, and some later become public. Public companies have much more onerous reporting and regulatory requirements.

There are two kinds of private limited companies, but the only relevant one is the “private company limited by shares.”

Private companies are owned by their shareholders. The more shares each shareholder owns, the more of the company they own. If you are currently a sole trader and incorporate your company, you will be the only shareholder unless you bring on other investors.

As a shareholder, liability in your company is limited to the value of your shares in the company. These shares are also known as equity. Hence, if the company can no longer pay its debts, the shareholders are only ever liable for the amount of equity they have in the company. 

An Example

Suppose that you wish to incorporate a company. Upon filing the necessary paperwork, you transfer £100,000 of your own money into the company. In exchange, you decide to issue yourself 10 shares.

The value of the company is now worth £100,000 (or £10,000 per share).

If the company begins to trade, and in a year through hard work, the £100,000 has grown to £150,000. You still have ten shares, but now each is worth £15,000. Your equity will have grown by 50%.

You decide to declare the £50,000 as profit and pay yourself a dividend (after paying corporate tax). The company is now back to where you started.

Suppose in the next year, your company cannot trade because of a pandemic, and you made no money while now also owing all of your suppliers a total amount of £120,000. In that case, the bad news is that a court will likely put your company into administration (bankruptcy for a company). Likewise, they will distribute all the remaining assets to your suppliers.

This is no doubt unfortunate. The £50,000 (less corporate tax) is of no real consolation because you lost half of what you put in. However, the real benefit of the private company reveals itself when you learn that your creditors cannot come after you, in your personal capacity, for the remaining £20,000 (unless you behaved fraudulently).

Considerations 

The UK’s tax system is quite favourable towards limited companies, especially when there is only one shareholder.

The disadvantage is that there are strict regulations for limited companies. Likewise, they require a good amount of paperwork to create and a lot of responsibility to maintain. A good amount of the information is public, including your name as a shareholder and your address (if you own 25% or more of shares).

For small companies, if you are the only shareholder, you must also act as the director. An exception is if you choose to hire someone to be a director. Being a director requires substantial obligations, duties, and responsibilities. It is not a duty to assume lightly.

Limited Liability Partnerships

These are relatively new business structures that combine the flexibility of partnerships with the limited liability of a limited company. You have to be in partnership with at least one other person. Therefore, you cannot set one up if you are to be the sole partnership.

Limited liability partnerships (LLPs) are flexible because you and your partners are free to decide the terms of the agreement, such as profit sharing and the duties you owe one another.

Each of the partners is not liable for any of the liabilities the partnership incurs because of the principle of limited liability explained above.

Partners are taxed as if they were in an ordinary partnership.

Key Takeaways

Unincorporated business structures come about naturally. If you are already making money in your own capacity, you are a sole trader. Likewise, you have a partnership if you and a friend run a weekend business painting houses for some beer money. They are beneficial because they are flexible and require no formalities or administrative upkeep (except for keeping on top of your taxes). The downside is that your personal assets are not separate from the company. If a third party sues your business or your business owes money, your personal assets are liable.

To limit your liability, you can incorporate as a limited company or, if it is you and another, a limited liability partnership. Your personal assets will be safe from your business debts. The downside is the administrative obligations and responsibilities that come with being a director. What is best for you depends on the size of your business and your long-term plans.

If you need help choosing between the different business structures, our experienced business lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.

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