When starting up your business, it’s worth taking time to think through which legal structure will be the best for you and the way you intend to do business.
The legal structure you choose will affect:
- the business records and accounts you require to keep
- the way in which management decisions are made about the business
- which authorities you require to notify about your business start up
- the tax and National Insurance you will be due to pay
- your financial liability in the event your business runs into trouble
- the ways in which your business can raise investment
There are several different structures to choose from, including starting up as a sole trader, entering a business partnership or starting a private limited company. If your business has social aims you may also consider setting up a community interest company or social enterprise.
This is the simplest form of business as it can be established without legal formality and does not require any registration fees to be paid to Companies House. You can start trading quickly and you have complete control over how your business is run. If the business is going to be dependent on you and your skill set then this may be a good option to consider.
It is important to be aware that as a sole trader you are personally liable for any debts that your business runs up. If you do not plan to raise finance however, this may not be an issue. Some businesses may start up as sole traders and review legal status further down the line, at the time they are considering investment options.
As a sole trader you are self-employed and the following tax and National Insurance criteria apply:
- your profits are taxed as income
- you pay fixed-rate Class 2 National Insurance contributions (NICs) regardless of any profits you make
- you pay Class 4 NICs on any profits
- you need to register for Self Assessment and complete a tax return each year
- If your business is likely to reach the level required for compulsory VAT in its first year, you should register straight away with HM Revenue & Customs.
In a partnership two or more people are involved in the business. They share the risks and the costs of the business and they also share the profits too. This structure can help share the load of business work and management and may also make it easier to spend time away from the business.
A partnership is similar in nature to a sole trader, but as more people are involved it is good practice to draw up a written agreement and for all partners to be aware of the terms of the partnership. For example, if the partnership doesn’t work out, an agreement will set out the basic principles which will apply, including share of profits and individual roles and responsibilities.
As with a sole trader, the business and personal affairs of the partners are not legally separate. Each partner must register as self-employed and is personally responsible for paying tax on their share of the profits and gains and paying for their National Insurance contributions. The partnership must also be registered for self-assessment.
In addition to a ‘standard’ partnership, it is possible to set up a limited partnership or a limited liability partnership. A limited partnership is comprised of ordinary partners and limited partners. A limited partner’s liability is limited to the amount of money they have invested in the business and to any personal guarantees they have given in respect of any partnership debt.
A limited liability partnership creates a partnership structure where the liability of each partner is limited. There must be at least two members of a limited liability partnership and the extent of partner liability is limited to the amount of money invested in the business and to any personal guarantees given in respect of any partnership debt.
Limited partnerships and limited liability partnerships must register with Companies House, complete an annual return and file accounts with Companies House.
A limited company is a separate entity from its owners, with its own legal existence. The business affairs of a limited company are separate from the personal affairs of the owners, but there are legal requirements which must be adhered to, including specific accounting and audit procedures. The costs associated with setting up and administering a limited company tend to be higher than some other forms of legal status.
The business is controlled by a Board of Directors and liability for debt is limited. Directors will require to register for self-assessment and complete a tax return including details of their salary and any company dividends. More information on the responsibilities of being a Director can be found from the Institute of Directors. From a tax perspective, there can be a benefit in setting up a limited company depending on your personal circumstances and earnings.
Community Interest Company
A Community Interest Company, or CIC, is a type of company which aims to use its profits and assets for the public good. To qualify for Community Interest Company status, the organisation must demonstrate that its aims are in the interests of the community or the wider public interest. CICs are registered with Companies House as companies, but it is the CIC Regulator who decides whether an organisation passes the community interest test.
As a business, a Community Interest Company reinvests its surpluses to achieve its social objectives, rather than being driven by the goal of maximising profit for its shareholders or owners. All Community Interest Companies have a compulsory asset lock. The assets of a Community Interest Company may only be used for the benefit of its stated community and cannot be distributed to members or investors.
A social enterprise is not a legal status and the phrase actually refers to the way in which an organisation or business is operated. Social enterprises can have different legal statuses including Community Interest Companies, charities and co-operatives.
The definition of a social enterprise is evolving but it is generally regarded as an organisation which trades primarily for a social or environmental purpose, reinvests profits or income in pursuit of its stated purpose and earns 50% or more from trading activities. If you’re interested in starting up as a social enterprise, you can find out more at Social Enterprise Scotland.