4 July 2023

The Lifecycle of a Business - Which business structure should I choose?

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina.

On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So, First Things First…..

Which business structure should I choose?

There are several options when it comes to choosing a business structure and the right one for your business will depend on a number of factors. Choosing the correct structure is an important decision as it will affect the way that your business is organised, your and your business’ legal obligations and tax position, filing requirements and your personal liability to third parties. It is therefore important to take professional advice about the best option for you and your business but it is also worthwhile to remember that the structure you choose is not set in stone and can be changed as the business develops.

When thinking about which business structure will work for you, it may be helpful to consider the following:

  • What type of business is it? For example, is it labour or capital intensive, is it involved just in the domestic market or internationally, does it undertake a regulated or non-regulated activity, is it innovative or established, etc.?
  • Who owns the business?
  • Who do you want to manage the business?
  • What is the tax position of each structure?
  • How risk averse are you? Is personal liability a potential issue?
  • What are the costs involved in setting up and running the structure?
  • What formalities do you want to deal with? Is a structure with increased formalities worthwhile at this point in your business’s lifecycle?
  • Are you happy for certain information to be made public?
  • Are exit strategies important to you, for example, are you likely to want to sell your business in the future?

Below are the most common forms of English business structure and their main characteristics. (It does not cover structures in other jurisdictions, including Scotland.) A table showing the main points is included at the end of the note for easy reference.

Sole Trader

  • A sole trader runs the business as an individual in their own name; the business is not a separate legal entity.
  • The individual receives 100% of any profit but also bears 100% of any loss and is responsible for all debts and liabilities of the business.
  • A sole trader makes all of the decisions relating to the business.
  • There are no incorporation or ongoing filing requirements although a sole trader will need to inform HMRC that they are self-employed and may have to register for PAYE. VAT registration may also be required. Note that some trades may require other regulatory obligations to be fulfilled.
  • A sole trader pays income tax and makes national insurance contributions through self-assessment and is individually responsible for paying these.

General Partnership

  • General partnerships are governed by the Partnership Act 1890 and any partnership agreement put in place between the partners.
  • Two or more persons own and run the business together with a view to making a profit.
  • A general partnership is not a separate legal entity to its owners.
  • Any profits will be shared between the partners and all of the partners are personally responsible for any losses, debts and liabilities of the business. As a result, a third party could reclaim the whole of any debt from one single partner.
  • To protect the partners, it is crucial that a partnership agreement is agreed and put in place setting out how the ownership, profits and liabilities are to be divided between the partners and how decisions are to be made. A mechanism for dealing with disagreements between the partners or deadlock situations should also be covered.
  • A general partnership has no incorporation or ongoing filing requirements, although it may be registered for VAT and, if it has employees, PAYE.
  • General partnerships are 'transparent' for tax purposes; tax liability falls on the partners who are taxed on their share of the profits or losses of the general partnership.

Limited Partnership

  • Although limited partnerships are primarily governed by the Limited Partnership Act 1907, the partners are generally free to agree a partnership agreement setting out their relationship to each other and how the business will be managed and administered. Putting in place a partnership agreement is highly recommended.
  • Two or more persons own and run the business together with a view to making a profit.
  • Two categories of partners are required – at least one general partner and at least one limited partner.
  • The general partner is responsible for managing the business and making any business-related decisions and will also have unlimited liability for any debts or liabilities of the limited partnership. As a result, it is common for the general partner to be a company with limited liability.
  • Limited partners provide the capital but cannot take an active role in the management of the business. As a result, their liability is limited up to the amount of capital that they have contributed (which is often nominal). Any limited partner who does take part in the management of the business will lose their limited liability status.
  • Registration of the limited partnership at Companies House is necessary and there are some ongoing filing requirements. Typically, the VAT registration of a limited partnership is achieved by the general partner being VAT registered.
  • Limited partnerships are tax transparent with the individual partners being charged income tax on any profits.
  • Due to the limited liability afforded to the limited partners, tax transparency and asset protection measures, limited partnerships are often used for fund investment purposes, particularly for real estate ventures, although a limited partnership may be a collective investment scheme (CIS) for regulatory purposes unless a relevant exemption applies.

Limited Liability Partnership (‘LLP’)

  • Although LLPs are primarily governed by the Limited Liability Partnership Act 2000, the partners or members can put in place an LLP agreement which can override many of the statutory provisions. Putting in place an LLP agreement is highly recommended.
  • Unlike the business structures discussed so far, an LLP is a legal entity separate from its owners. It can therefore enter into contracts in its own name and can sue and be sued. The partners or members have limited liability up to the amount of any capital contribution they have made.
  • At least two ‘designated partners’ must be appointed to deal with the LLP’s administrative obligations, including making any necessary filings at Companies House. Failure to appoint two designated members means that all of the partners will be deemed designated members.
  • LLPs must be incorporated at Companies House and comply with ongoing filing requirements. As a result, certain information about the LLP is publicly available, although the LLP agreement is a private document. An LLP can also be VAT registered and if an employer, will need to register for PAYE.
  • An LLP is transparent for tax purposes with the partners being individually liable for any tax charged on the income profits and gains.

Limited Companies

  • Limited companies are separate legal entities to their owners – the shareholders or members.
  • It is possible for one individual or entity to own 100% of the shares in a private limited company.
  • A limited company has limited liability either by shares (which is usual) or by guarantee (primarily used by not-for-profit organisations); each member’s liability is limited to the nominal value of their shares (plus any premium paid) or the guaranteed amount.
  • The rules for incorporating and running a company in England and Wales are primarily set out in the Companies Act 2006 (‘CA 2006’). A private company must be incorporated at Companies House and is subject to various ongoing filing requirements. As a result, a lot of information about a limited company is publicly available. A limited company can also be VAT registered.
  • A limited company's articles of association, together with the CA 2006, set out its constitution and detail how it will be managed and run. Private limited companies may also have a shareholders’ agreement in place which provides further detail and protections for the shareholders, particularly for those holding a minority of the shares or where the shareholders have equal voting power. Shareholders’ agreements are usually private documents and are not publicly available.
  • Default model articles of association can apply although these can be amended by the shareholders to ensure that they reflect the true management and governance of the company.
  • Limited companies can be either private limited companies or public limited companies. Private limited companies cannot sell their shares publicly, for example, on a stock exchange, although a public limited company can. As a result, public limited companies have many more compliance requirements than private limited companies, but even private limited companies are heavily regulated compared to the other business structures referred to here.
  • The day-to day management decisions of a private company are made by its directors, who can also be shareholders. Directors have various duties and obligations, breach of which can lead to civil and/or criminal sanctions.
  • The CA 2006 provides that the shareholders are responsible for certain decisions and the shareholders’ agreement may also provide that certain matters require shareholder approval.
  • Any profits are kept by the company, which then declares a dividend to be paid to the shareholders.
  • Limited companies are 'opaque' for tax purposes; they are taxed separately from their shareholders. The company will itself be liable for corporation tax, while its shareholders who are UK tax resident individuals will pay income tax on any dividends they receive.
  • In terms of an exit strategy, selling a company or business is relatively straightforward compared to the other structures referred to. The assets and business of a company can be sold separately (an asset sale) or the entire company can be sold (a share sale). That said, exit strategies can be complex and have significant tax consequences and so legal advice should always be sought as soon as possible.
 


English business structures

  Sole trader General partnership Limited partnership LLP Limited company
Separate legal entity? No No No Yes Yes
Tax Individual Transparent Transparent Transparent Opaque
Liability Unlimited Unlimited Limited for limited partners
Unlimited for general partner, unless it is a limited company
Limited Limited
Profit 100% to individual 100% to partners, subject to any partnership agreement 100% to partners, subject to any limited partnership agreement 100% to partners, subject to LLP agreement 100% to company, which pays dividends to shareholders
Management Individual Partners General partner As set out in the LLP agreement, although 2 designated members required Directors deal with general management, subject to articles and shareholders’ agreement
Incorporation and filing requirements None None Some filing requirements Yes Yes
Minimum number of owners 1 2 1 limited partner and 1 general partner 2 1
Primary legislation None Partnership Act 1890 Limited Partnership Act 1907 Limited Liability Partnership Act 2000 Companies Act 2006
Primary documents None Partnership agreement Partnership agreement LLP agreement Articles of association
Shareholders’ agreement


Disclaimer

This note reflects the law as at 4 July 2023. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

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