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As a new or prospective franchisee, a critical decision you will face is selecting the appropriate legal structure for your business. Your business’s structure determines your personal liability, tax obligations, and the framework within which you will operate. Each structure offers distinct considerations. This article will explain each business structure and how to choose the most suitable option for your new franchise business.
Business Structures and Franchising
The franchising structure is a unique business model in which a franchisor grants individuals or entities (franchisees) rights to operate under their established brand. The franchisor benefits from an expanding brand presence, while the franchisee gains access to a proven business model and the franchisor’s ongoing support.
Franchisees operate independent businesses that are separate entities from the franchisor’s. For this reason, as a franchisee, you will need to choose a legal structure for your business. This decision is not just about filling out paperwork; it fundamentally shapes:
- how your business operates;
- its tax obligations; and
- liability considerations.
It is crucial to choose your legal structure carefully. Your chosen structure will determine the extent of your liability and the taxes you and your business must pay.
Types of Business Structures
1. Sole Tradership
Operating as a sole trader is the simplest form of business structure. It involves you owning and operating the business alone. The particular benefits of this structure are that you have complete control over the business, and it can be simple to set up and operate.
Acting as a sole trader also carries risks. You will assume personal liability for any debts or legal issues your franchise business may encounter. These can be expensive to resolve. You may also lose substantial personal assets and face significant debts if something goes wrong.
2. Business Partnership
Partnerships involve two or more individuals sharing the ownership and management responsibilities of the franchise. In this structure, it is essential to have an explicit partnership agreement outlining roles, responsibilities and profit-sharing arrangements. Business partnerships can be:
- general: where all partners share equally in profits and liabilities; or
- limited liability partnerships (LLPs): where partners’ liability is limited to their investment in the business.
Similar to sole traderships, establishing a general partnership does not require formalisation. This structure automatically forms when two or more individuals collaborate on a business venture, sharing the responsibilities and profits. LLPs, however, exist as separate entities and require incorporation.
3. Limited Company
Like LLPs, limited companies require incorporation through registration with Companies House. This structure limits an individual’s personal liability to their investment while allowing them to participate in management and decision-making. Some franchisees favour this structure because they want to balance protection and flexibility.
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How to Choose the Right Business Structure for Your Franchise
1. Understand Your Options
Begin by familiarising yourself with the various legal structures availiable for businesses. Also, consult the franchisor and carefully read the franchise agreement. Some franchise systems may have specific requirements or recommendations regarding the legal structure of franchisee-owned businesses. It is also essential to seek independent legal and financial advice to understand the implications of different business structures.
2. Consider Personal Liability
The level of personal liability you can accept depends on your circumstances and is essential in determining the most suitable structure for your business. Sole traders and general partners’ businesses are not legally separate entities. There is little to no separation between personal and business liabilities. Therefore, you will likely be fully responsible for any business debts and legal claims. However, limited companies and limited liability partnerships provide limited liability protection. This can shield your personal assets from business-related liabilities.
3. Consider Tax Implications
You must familiarise yourself with the tax implications associated with each structure. For example, sole traders and general partners typically report business income and expenses through their personal tax returns. These are subject to income tax rates.
This handbook covers all the essential topics you need to know about franchising your business.
4. Seek Legal Advice
You should seek guidance from legal professionals with expertise in franchising. They can advise you based on your specific circumstances. Additionally, they can help you understand the potential risks of each business structure.
Key Takeaways
Choosing the most appropriate structure for your new franchise business is more than a formality. It is a crucial decision that will shape your new venture. There are a handful of different structures to choose between, including:
- sole tradership;
- general business partnerships;
- limited liability partnerships; and
- limited companies.
You need to understand the advantages and disadvantages of each option and seek independent advice to make an informed decision. Then, remember that you can periodically reassess your chosen structure as your franchise business evolves.
If you would like advice about choosing the most suitable legal structure for your franchise, our experienced franchise 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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