Starting a new business involves many decisions, and one of the most important choices is selecting the appropriate legal structure.
The legal structure you choose can significantly impact your business, including tax liabilities, regulatory compliance, and personal liability. That's why it's crucial to carefully consider your options and make an informed decision from the outset.
In this article, we'll focus on the legal aspects of choosing a legal structure and provide practical guidance to help you choose the right one for your business. Additionally, we recommend speaking with an accountant to ensure you understand your chosen legal structure's tax and accounting implications.
What are the main legal structure options available?
The simplest form of legal structure if you are going into business on your own is to set up as a sole trader, which means you’re in business as self-employed in your own personal capacity.
You can use a trading name if you wish, but the key point to understand here is that you’re personally liable for your trading liabilities and, as such, your personal assets will be at risk.
The main alternative to the sole trader structure is the private limited company route. In this structure, the company is the legal entity that trades, as opposed to you personally, and as such, the liability is generally limited to the company’s assets. You can be a director and shareholder of your own company.
If you’re going into business with others, you can form a limited company together, where each of you has shares and directorships.
If you’re doing business with others and prefer not to form a company together, you can enter into a traditional partnership (or ordinary partnership). This is similar to the sole trader route in that each of the partner’s personal assets would be placed at risk, but the difference is that you’re all in business together.
There is a variation in the traditional partnership model, which is the Limited Liability Partnership (‘LLP’). This structure has some similarities to a limited company and some similarities with a traditional partnership, so it’s akin to a hybrid model. LLPs predominantly feature in specialist fields, such as e.g. professional services (solicitors and accountants, etc.). In this piece, we’ll focus on the other three structures (sole trader, traditional partnership and limited company).
How to choose between each option, and what are the pros and cons?
This may be a good option if you want a basic structure to get up and running quickly in a low-risk industry with very few or no employees.
If you’re a hairdresser, cafe owner, or small retailer with a single shop or sell clothes online etc., you might see the sole trader route as an attractive option.
It tends to suit situations where the industry is not high-tech or capital-intensive, and you don’t have significant trading liabilities or high inventory values.
The sole trader route is generally to be avoided whereby the nature of your business is potentially high risk and/or you have an ongoing need to raise lots of finance for trading and growth purposes.
Also, as a general rule, the sole trader route doesn’t tend to favour situations where you’ll enter into high-value/long-term business-to-business (‘B2B’) contracts.
Private Limited Company (PLC)
This route may be preferred where you’re taking on more trading risks and liabilities and/or planning to scale the business, including raising finance, recruiting staff, taking on more premises, etc.
It’s also a good option if you’re going into business with other co-founders and want a nice and solid corporate foundation to establish the business.
The limited company route allows the formal division of ownership and management. As such, it’s a great structure if you’ll be recruiting non-shareholder directors or seeking investment from investor-only shareholders without a role in the management of the business. You must be aware that the accounts and other key details related to the company are a matter of public record and accessible from the Companies House.
A partnership can be ideal if you plan to start a business with other partners but don't want to establish a formal company structure for any reason.
You may want to keep the details of your business private and avoid having them publicly available on Companies House. Alternatively, you may prefer a less administrative burden than running a company.
However, it's important to note that in a traditional partnership, each partner's personal assets are at risk of trading liabilities, making it more suitable for lower-risk sectors.
Choosing the right legal structure is crucial when starting a new business. It can significantly impact several aspects of your business, such as tax liabilities, regulatory compliance, and personal liability. Take a look at our sole trader business expenses guide for more in-depth insights into this structure, or explore the alternative with our private limited company guide. Find even more business guides online at Crunch, and choose a structure that will help you to achieve your career goals.
It’s essential to carefully consider each option's pros and cons, considering your industry, trading liabilities, number of employees, and business goals. The right legal structure for your business can lay a solid foundation for growth and success.
Crunch’s partner, LawBite, understands the importance of making the right choice, and their team of lawyers are here to help with any commercial, corporate, and employment legal matters you may have. Their team of experts can provide guidance and support to ensure that your business is on the right track from day one. Book a call to get legal advice and support from Lawbite.
About the author
Ashley Gurr is a commercial and contract lawyer at LawBite. Ashley has over 15 years of experience in private practice helping SMEs and in-house for an international consultancy group advising on commercial contracts and a multinational utility giant in a contract strategy role.