Sole Trader, Partnership or Limited Company?
There are various models you may choose to adopt for your small business. This article looks at three possibilities – sole trader, partnership and limited company – and discusses the pros and cons of each.
The simplest business model for an entrepreneur to adopt is that of a sole trader. This simply means that you, as an individual, are engaging in business activities.
It’s not even necessary to set up a separate bank account for your small business activities as a sole trader, although it’s usual to do so. As long as you keep records of your business income and expenses and record them properly on your tax return, there’s very little in the way of mandatory paperwork: you can just get on and start earning money.
A partnership operates rather like a sole trader, except that the small business is owned by more than one person jointly (up to 20 for most type of business).
However, in addition to general partners, who are liable for all debts and obligations of the business, a partnership may also have limited partners. A limited partner contributes a certain amount of money to the partnership and is not liable for anything over that amount.
There is more than one company type. The three main ones are a private company limited by shares, a private company limited by guarantee and a public limited company. As a small business entrepreneur, you are most likely to set up the first company type, issuing shares.
A private company limited by shares (Ltd) raises its money by selling shares (to directors or investors). The shareholders’ liability is limited to any amount remaining unpaid on the shares they own (typically zero). The company is treated as a separate legal entity, and its directors must work in the best interests of the company.
Profit made by the company stays within the company until it is paid out in the form of salary to employees or dividends to shareholders. Directors of the company may also be both employees and shareholders. Company profits are subject to corporation tax, which is higher than basic-rate tax but lower than higher-rate tax.
Consider a typical scenario for a small business with two directors, each of whom owns half the shares and does half the work. Each director may draw a small salary up to their tax-free allowance, and take the remainder of their income in the form of dividends. This may save them tax compared with working as a partnership and paying income tax on their profits.
Your small business may appear more legitimate if it is a limited company rather than a sole trader or partnership, while at the same time limiting your personal liability to any losses incurred by your business and reducing the tax you have to pay. If you have a very small business, you can even set up a one-person company (which is surely a contradiction in terms!).
Choosing the Right Model for Your Business
Of course, choosing a suitable structure for your small business is an important decision and it may pay you to speak to an accountant. They will be able to advise you according to your needs, and can help set you up in business (for example, by recommending financial software, providing templates for your records, or forming your limited company for you).
Whichever structure you choose for your small business, it’s important to understand your legal and financial responsibilities, and to protect yourself if necessary. For example, if you are a sole trader and you are sued for negligence, there is no legal separation between you and your business – you could potentially lose everything if you lose the case. Perhaps some professional indemnity insurance would be in order!