Sole trader
As a sole trader, you trade in your own name and are taxed
as self-employed. There are no formalities for you to follow and your trading
results are a private matter. All the benefits and risk of trading are yours
alone.
Partnerships
In a partnership, you are in business with others. Profit
and risk of loss is personal to the business partners and is shared between
them. It's possible to trade without a written partnership agreement but it is
best not to do that.
A 118-year-old law implies the terms of the agreement between partners in the absence of a written agreement but the outcome may not suit you. You can ask your solicitor for an estimate on the cost of preparing a written agreement to record how decisions should be reached; how profit and risk will be shared; and what happens if a partner wants to leave or dies. Partners assume unlimited liability to their customers and suppliers. Tax on profits is personal for each partner.
Limited liability partnerships (LLP) differ from ordinary partnerships because the profit and risk of loss belongs to the LLP and there are a few formalities to observe. Profits can be kept in the LLP for future trading or paid out to members (tax on profits is personal to each member). Again, a written agreement is a good idea to record how the LLP should operate. Your personal risk would be limited to your investment in the LLP.
Company
Trading through a company means you own shares in the
company and the company owns and operates the business. The formalities of
running a company mean you are likely to need legal and accountancy advice
every year, so your administration costs will higher than other business types.
Decisions are made by directors of the company (you would be one, either alone
or with others you invite to join you) and must be made in the best interests
of the company, not the directors.
Profits and losses and risk of trading belong to the company and tax is levied on the company's net earnings. You can receive a share of trading profit either as income paid to you as an employee, fees paid to you as a director or dividends paid to you as a shareholder. The law governs what you money you can be paid as a director or shareholder. Your personal risk is limited to the amount you paid for your shares.
Making your choice
Speak to your accountant and solicitor before making your
choice and check how your personal situation may be affected by your decision.
Your choice is likely to be a function of the projected scale of your business
and whether you want to go it alone or run the business with others.
Sole traders are usually self-reliant, tending to operate small scale, low risk businesses with no or few employees; funding is usual personal or using a small loan or overdraft from a high street bank.
Ordinary partnership is suitable for a group of people who wish to trade together under a shared business name and are willing to assume unlimited liability. Being a group, partners tend to have greater leverage on trading terms, borrowing money and leasing property.
Limited liability partnerships carry the benefit of limiting personal risk for business partners without the formality of running a company. A disadvantage is that, unlike ordinary partnerships, LLP must publish their trading figures in the form of annual accounts.
In both types of partnership, new partners can join the partnership with the consent of the existing partners. Without a written agreement, it is problematic when partners wish to leave.
A company is a suitable format for a business that is likely to scale up quickly using third-party investment (in the company's shares) and which may incur trading risk that you are unwilling to assume personally. The limited liability format permits investment in the trading opportunity without the requirement of personal participation in the business that usually follows from joining a partnership.
Neil Morgan is a partner at Winckworth Sherwood
