Trading structures for new business start-ups

There are several different trading structures for new business start-ups in the UK and this post compares each of them.

New business start-ups

When you're a new business start up you must operate through a trading structure or 'vehicle'. The three types of structure commonly used in the UK are as follows:

  • A sole trader
  • A partnership
  • A company

Sole trader

This is the most straight-forward trading structure for new business start-ups  It consists of one self-employed individual, running a business on their own. 

Because of it's flexibility the sole trader is the most popular trading vehicle in the UK for new business start-ups. However, if you're a sole trader you're personally liable for the debts of your business. Therefore your personal assets could be at risk if your business is not successful and you might become bankrupt. 

All of the profits of your business are taxed as your personal income of the sole trader so this makes managing your tax liabilities less effective than say a limited company. However, if your business makes losses in the early years of trading there is more scope for claiming tax relief on these trading losses.

If you're a sole trader you can employ staff, though you cannot rent your own land or property to your business or charge yourself rent. We've covered this particular aspect in a previous post.

Partnership

The legal definition of a partnership is two or more persons carrying on in business with a view to making a profit. A person might be an individual or any other entity. For example another partnership, a company or trustees. 

There are different forms of partnership which are governed by different partnership acts. These are discussed below. Certain persons are not permitted to form partnerships, namely  Charities and Not-for-profit organisations.

The four different forms of partnership are as follows:

  • General partnership
  • Limited partnership
  • Scottish Limited Partnership
  • Limited Liability Partnership 

General partnership

This is governed by the 1890 Partnership Act and shares a lot of the key features of a sole trader. For example partners are responsible for each other's partner's debts and they are taxed on all their profits. Although each partner's profit share may vary according to any agreement made. 

However there are some significant differences from a sole trader. There may also be restrictions in claiming loss relief for those non-active partners. Individual partners can also rent property to the partnership and charge rent accordingly. 

Limited partnership

This type of partnership is governed by the 1907 Limited Partnership Act.  It is different from the Limited Liability Partnership (LLP) which we discuss below.

Limited partnerships tend to be popular when you are structuring a private equity and investment fund. However they are not suitable if you're looking for a flexible trading vehicle. You therefore might want to use a conventional partnership or LLP instead.

A key aspect of this type of partnership is that at least one partner must have unlimited liability. They are referred to as the  'general partner', The limited partners’ liability is capped, so if the business fails (unless there is fraud or something similar), they only lose the capital they contributed in order to join the partnership.

Usually the limited partner provides initial funding though is not allowed to participate in management or bind the partnership. A limited partner’s entitlement to loss relief is also restricted pro-rata to its capital contribution.

Scottish Limited Partnership 

This partnership is also governed by the 1907 Limited Partnership Act. Under Scottish law, an Scottish Limited Partnership is a combination of a conventional partnership and limited partnership.

Scottish Limited Partnerships like limited partnerships are popular for structures for investment funds.

A Scottish Limited Partnership must have one general partner and one limited partner. The limited partner(s) are not permitted to take any part in the management of the Scottish Limited Partnership. However this type of partnership can hold assets, make contracts, sue and be sued and act in many ways as if it is a separate legal entity to its owners. It is taxed transparently just like a general partnership (see above).

Limited Liability Partnership

This business vehicle is a hybrid of a general partnership and a company and arguably may have the best features of each. Limited Liability Partnerships are governed by the 2000 Limited Liability Partnership Act and the 2006 Companies Act.

A Limited Liability Partnership  is regarded as a separate legal entity to its members (the partners). This type of partnership has designated partners who are the equivalent of company officers (directors) and accounts are filed with Companies House.

The Partners have limited liability unless a Limited Liability Partnership becomes insolvent and the partners knowingly allowed this to happen. In this case, they may be required to repay their profits of the previous two years. Limited liability does also not apply where a partner is found to be at fault at a time when he was acting under his own personal capacity.

The partnership is taxed like a conventional partnership although losses are restricted in proportion to each partner’s capital contribution. Limited Liability Partnerships  are subject to substantial tax anti-avoidance legislation perhaps because of HM Revenue's perception that they have been used extensively for anti-avoidance previously.

Why have a partnership agreement?

Because partnerships are relationships and a relationship can go wrong it is sensible to have a partnership agreement especially if you're a new business start-up. This should cover profit share, capital contributions, how to deal with the arrival and departure of a partner, succession, and death or divorce of a partner as an absolute minimum.

Holding land or property

Just because two or more persons hold a joint or common interest in land does not, according to the Partnership Act, mean they are a legal partnership, even though they may split the profits generated by their land or buildings. For tax purposes, each partner is assessed on their own share. No partnership tax return is required for a property business.

By concession, a trading partnership that also has insubstantial income from land and property these will  be assessed as if all its profits are trading profits.

Limited company

Last and by no means least, there is the limited company which is used as a trading structure for new business start-ups. The two main forms of limited company are Private and Public.

Private companies

A private company can be unlimited or limited by shares or guarantee. Unlimited companies and companies which are limited by guarantee tend to be used for activities that have little or no commercial risk. Alternatively, they may be operated as non-profit making or charitable companies.

A key aspect of a company limited by shares is that it is is a separate legal entity to its owners and its directors. A company has an authorised share capital and shareholders invest in the company and own its shares. It is taxed on its profits and Its owners are only taxed when the company distributes its profits to them (for example as dividends). 

The company is run and managed by its board of directors and a company secretary is required to maintain the company's statutory records

A company may be a 'single member' company, which is owned by one individual who may be both it's director and secretary.

If a company  becomes insolvent, the shareholders will generally find that their shares are worthless. They lose the money that they have invested in them. If any amount of share capital is unpaid, the shareholders will have to settle this. If the company does become insolvent, its directors may have to account to creditors if it is proved that they have suffered a financial loss as a result of their actions.

Because shareholders and officeholders can fall out, it is essential to consider both a shareholders agreement and director's service contract. This is particularly important where you are new business start-up with outside investors.

Public companies

A public company is set up in a similar way to a limited company, except that it is permitted to apply for a listing on a recognised stock exchange and is able to offer its shares to the general public in order to raise finance.

A key feature of a public company is that it has a minimum issued share capital of £50,000 of which at least 25% must be paid up. Detailed disclosures are also required under listing and exchange rules for reporting company information and directors' interests.

A public company  is governed by an executive board of directors and non-executive directors and all of it's directors should comply with the rules of corporate governance.

Joint Ventures

A joint venture is an arrangement made between two or more parties to work together. It will typically be set up as a company (referred to as a joint venture company or as a partnership (generally using an Limited Liability Partnership). We have covered aspects of this type of arrangement in a previous post here.

A joint venture is not a legal entity, it is simply a term used to cover an arrangement. If it is set up via another trading vehicle it may have the legal capacity to enter into contracts or be sued. There are also a number of different tax considerations which will arise as a result of a joint venture, depending on the different types of legal entities that formed it.

For more useful information, check out our Ebooks here.

And if you'd like to know how we can help you with all of this, or with anything else, feel free to give us a call on 01202 048696 or email us at richard@tfaaccountants.co.uk.

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