Quick guide: business structures
Start-ups will be faced with a number of important decisions, one of the earliest being the legal structure for your business.
The structure you choose will affect your legal responsibilities, including the initial paperwork you will need to fill in, your tax liabilities and personal responsibilities if you make a loss. There are three main types of businesses in the UK: sole traders, limited companies and business partnerships. But which is right for you? You can always change to a more sophisticated model as your business progresses, but here is a brief breakdown of options to help you make that all-important initial decision:
Registering as a sole trader is perhaps the simplest of structures, ideal for those starting out on their own and testing out their business concept. It is easy to start – you just need to file one form with the HMRC to inform them that you are in business – and is low cost to run. You then file one tax return with them each year, so paperwork is relatively low. This is the most popular option amongst solo business owners who operate by themselves, or are a start up. Being a sole trader doesn't mean you can't take on employees, it just means you are responsible for your business. In fact, in the eyes of the law, you are your business – meaning everything you make belongs to you (after tax). The downside to this, however, is that because the law doesn't make a distinction between the business and its owner, any business debt can be made against your home, car and other personal possessions.
A partnership is a common extension of the sole trader structure and is just as flexible, and it has the benefit of two (or more) heads. The legal requirement with a standard business partnership is that each partner registers as self-employed and puts in an individual tax return. You will also be responsible for any losses made by your company and bills for items bought for your business. A consideration with regard to limited liability partnerships is that tax is charged on all profits (even if they are not distributed to members) and you will have to register with Companies House, meaning there will be more paperwork involved.
As your business grows, you may realise the advantages of having a limited company – an organisation set up to run your business. Registering your limited company at Companies House will lend credibility to your business, and many owners believe it makes it easier to win contracts and new clients. Although being managing director of a company will bring status, it will be more of a struggle when it comes to year-end accounts. A limited company is more complex to set up and run and involves a lot more paperwork. Every year you will need to file four documents: annual return, annual accounts, a tax return for the company and a tax return for yourself. It is worth remembering that your business profit figures etc. are available to the public – a copy of your annual return and accounts can be bought by anyone from Companies House. An increasing number of established contractors, consultants and professional service firms choose to operate as limited companies.
Protecting against allegations of mismanagement
It's a common misconception that, as a director, you are not held personally responsible for your actions in the course of your business. The truth is that directors can be held personally responsible for mismanagement of their business and legal action can be taken against them – and many directors have to fund their defence out of their own personal wealth, which can have severe consequences for their personal life.
However, insurance cover is available which can limit the financial impact. Directors and officers insurance can cover the costs of defending you as a director or officer of your company against allegations of wrongful acts, and any damages subsequently awarded against you. It also covers the legal costs and expenses of defending you against disqualification as a director, investigations and extradition proceedings. If you choose to operate as a limited company, you should give consideration to directors and officers insurance.
We offer specialist directors and officers cover from as little as £6 per month – get an online quote now to find out how little it costs to protect against the unforeseen.