This is the first part in a series of articles I am writing on running a company as these are issues the come up with my clients on a regular basis.
When you start up a business, you have a choice of the legal structure for it. The most commonly used structures are sole trader, partnership and registered company. I will briefly describe them here before talking about why you might opt to set up a company. In future articles, I will talk about responsibilities of running a company, understanding jargon and more.
Sole trader – this is what is commonly known as self-employed. I wrote a little more about this here. Self-employment is when you work for yourself – whether doing freelance or consultancy work or running your own business. It is very simple to start working as a sole trader with minimal paperwork involved, which in turn means minimal administrative costs.
Partnerships – these are effectively collections of sole traders who are working together. There is slightly more admin work involved in a partnership. As well as tax returns for all individuals, there needs to be a return completed for the partnership. Within a partnership, how any earnings are split can be amended at any time through an agreement between the partners.
Registered company – a registered company is an entity in its own right. If you are a sole trader or in a partnership, there is no legal distinction between you and your business. This is not the case with a registered company.
Running your business through a limited company is not the right setup for everyone, but I will talk through a few reasons why you might want to set up a company.
- Limited Liability. The word limited in your company name means that there is a limit on how much you stand to lose if something goes awry with your business. As a sole trader, there is no distinction between you and your personal assets. As a limited company is a distinct legal entity, this is not the case so there is protection for the owners of the business.
- Tax efficiencies. It is possible to reduce your tax liability by operating through a limited company. The main way to do this is to through paying yourself a combination of salary and dividends. You can also potentially reduce the amount of national insurance contributions that you need to make.
- Financing. You may be more easily available to securing financing for your business venture. Banks or investors may be more willing to lend money to a limited company, and it is also possible to offer shares in your company to would be investors.
- Going into business with other people. If you are running a business with someone else, then you have the choice of a partnership or a limited company. A limited company allows you all the above advantages listed here, as well as allowing you more flexibility around how the company develops.
- Separate legal entity. As a company is a distinct legal entity, this means it can continue to exist beyond the involvement of its original owners. They can pass on their shares and the company will continue to function. This is one key advantage over a partnership which will necessarily dissolve if there is only one partner left.
- Selling the business. Whilst it is possible to sell your business if you are a sole trader, the business having its own legal identity may make it easier to do so. You can also sell part of your business by transferring some of your shares whilst retaining some of the ownership.
- Professional image. A limited company might be seen as more respectable having a more professional image. This may help you to secure work in some fields where customers may only contract with registered companies.
- Protecting your business name. When you register with Companies House, your company name is legally protected. This is not the case if you are a sole trader.
- Deciding when to take your income. If you are a sole trader, your income is taxed as soon as you receive it. With a company, the company’s profits are taxed in the same way however you can decide when to take a salary or dividends from the company which allows you to both leave funds available for reinvesting or to take your earnings at the most tax efficient time.
- Allowable expenses. With a registered company, there are a few items that can be claimed as a tax deduction that you cannot when you are a sole trader. For example, if the company issues you a mobile phone, the whole phone bill can be deducted whereas with a sole trader you can only deduct a business percentage. Companies can also deduct the cost of pensions which is an efficient way to plan for your future. If you want pensions advice, I can point you in the direction of a trusted advisor.
There are some downsides to running a limited company, which include:
- Extra cost. Whilst a limited company can be a tax efficient way of operating, this is only the case if you are making enough money for it to be so.If you have minimal profits or are making a loss, then the additional costs of a business will not outweigh the benefits.
- More complex admin. There is a lot more paperwork involved in running a company, although you can employ an accountant who could do most of it for you.
- More reporting requirements. As a sole trader, you just need to complete your own personal tax return. A registered company will have a full set of annual accounts, a company tax return and a confirmation statement to complete – and you may still need to do your own personal tax return on top of this.
- Reduced private. As a registered company, a number of details are on the records at Companies House, such as the company’s registered address (often your own address but you can use mail forwarding companies to have a different registered address) as well as some of the company’s financial reports.