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How to structure your business




 

When you are setting up your business and you go to the bank to open your business current account, the bank will ask you what type of business structure you will have. For many businesses this question is unexpected and it is easy to feel pressured into making an on- the-spot decision about something that probably means very little at the time. [3]

However deciding on the structure of your business is very important. The decision you make will depend largely on the type of business you are starting so it is worth doing some research early on to help you make the best choice.

There are three types of business that you need to be concerned with: Sole Trader, Partnership and Limited Company.

Sole Trader & Partnership

The reason why these two are categorised together is that they are very similar in structure. Most small businesses start out as sole traders or partnerships and then later make the decision to become a Limited Company once the business is more established.

As sole trader operates exactly as the name suggests. You are actually trading in your own name. Even though you might call the business something completely different to your own name, your name will be on all official documentation. For example, say you had a pet shop called Pets-R-Us, this name would appear on the shop front but all bank statements and other official documents would call the business: John Smith trading as Pets-R-Us.

A partnership has the same set up as a sole trader, except that you have equal responsibility for the business with your partner or partners. The trading name on the official documentation would then say something like: John Smith and Claire Jones trading as Pets-R-Us.

Setting up as a Sole Trader or Partnership is usually a smart move for a start-up earning less than £50,000. This is because there are fewer legal responsibilities and less to pay in terms of tax. You would effectively be self-employed and manage the business finances in the same way – filling in a self-assessment tax return at the end of the year with your business income, expenses etc. and paying income tax and National Insurance.

You can register for VAT no matter what your turnover is, and the returns can be very beneficial for the cash flow of your business. However if your taxable turnover in the previous year or the next 30 days is more than £64,000, you must be registered for VAT by law.

If you are in a Partnership it is wise to draw up a legal Partnership Agreement, to ensure that all partners know where they stand. This is also very useful if you close the business down.

Many businesses decide to register as a Limited Company once they reach a certain level of turnover. This is because the major drawback of being a Sole Trader or Partnership is that you are personally responsible for any business debts if the company closes down. These debts are treated as the same as your personal debts, and any personal assets (such as your house) could be claimed to use for repayment.

In a Partnership, the partners are jointly liable for all business debts. Any partner can be pursued for the total amount of the debt – it is not shared out equally. This means that if the business fails and one partner is unable to cover their part of the debts owing, the other partner or partners will then be responsible for the whole amount.

Limited Companies

The two main reasons for setting up your business as a Limited Company are: 1) to take advantage of limited liability status, and 2) to take advantage of the trust that is implied by having the word Limited in your company name.

Limited Companies have directors and shareholders. There must be a minimum of 2 directors, and one company secretary (who can also be a director) who is responsible for submitting the company accounts to Companies House. However a limited company is separate from the directors and shareholders who may not be held personally responsible for any debts if the company becomes insolvent.

Unlike with sole trader status where your income is effectively the same as your salary, as a director you need to pay yourself a salary from the profits (if you decide to take money out) of the business, and use PAYE to arrange income tax and National Insurance. As a company director you also need to complete a self-assessment tax return each year to declare your salary and any benefits or additional earnings.

In addition to paying income tax on any salary you draw, you must also pay corporation tax on any profit. For profits between £1 and £300,000 the tax rate is 20%.

As a limited company there are many and varied legal requirements you must adhere to, for which a fine is payable if they are not complied with. These include employment laws – look out for Working Tax Credit, Maternity Leave, Statutory Sick Pay & Employer’s Liability Insurance – tax laws, health and safety laws and other regulations related to specific types of business. If you have 5 or more employees you are obliged to arrange a Stakeholder Pension.

If you are a Limited Company you also need to know the point at which you will be considered insolvent. A company is officially insolvent when it is unable to make repayments on its debts, or where the value of its assets is less than the amount of its liabilities. Assets include stock, fixtures/fittings, monies owed to you from customers or forthcoming work.

Although you may not be personally liable for the company’s debts, you are responsible for other aspects of the business, for example unpaid taxes, personal guarantees given on behalf of the company, fraud, trading while insolvent, etc.

As you will see by now there is much more administration work involved with running a Limited Company than as a sole trader or partnership. The decision you make as to the structure of your business will depend on what your capabilities are and your level of confidence as to the business’s potential success.

If unsure, take advice from experts.

 


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