Deciding to set up your own business can be an exciting yet daunting experience. You’ve come up with your business plan, but do you know what medium your business will take? Are you going to go it alone as a sole trader? How about a partnership? Maybe register as a company limited by shares?
This blog post will tell you about each business medium and provide you with the advantages and disadvantages of each one.
A sole trader is someone who is self employed. They own their business by themselves and have completely responsibility for it. That doesn’t mean to say you would have to work alone, a sole trader can have employees.
Profits from a sole trader’s business forms part of that person’s taxable income. This is subject to income tax which is paid via a self-assessment each year
|THE PROFITS OF THE BUSINESS ARE ENTIRELY YOURS – once taxes have been paid and any employee wages (if applicable), the remaining sum is yours to do with as you please.||UNLIMITED LIABILITY – By far the biggest disadvantage of setting up as a sole trader is that liability for the businesses losses and debts falls entirely on you. If your business falls on hard times, you will be liable. This can include your home being at risk as well as personal savings and any other assets you have both inside and outside of the business. Also, if for any reason a customer sues the business, they are essentially suing you.|
|CONTROL – As the only owner of the business, you will have complete control over the running of it. Decisions will not have to be put to a vote or require approval from anyone else making it easier and faster to implement changes.||FINANCE – Setting up as a sole trader can be expensive. You will need equipment, machinery and perhaps premises. These will need to be paid for out of your own money whether savings or a loan. Unlike a company, you cannot sell shares in the business to raise money.
|IMPROVED CUSTOMER SERVICE – It could be argued that as a smaller sole trader business you are able to offer a more personalised approach to your customers. This is because as the only owner you are a lot more involved in the business. It seems that you can develop relationships with customers, than can turn in to repeat loyal buyers as well as suppliers that can lead to cheaper rates.||SELF-STARTER – As the only person involved in the business at least to start with, you will have to do every job required from sales to cleaning. At the outset you will be particularly busy and it is down to you alone to keep on top of everything. This inevitably means working long hours including evenings and weekends.|
|LESS RED TAPE – Setting up as a sole trader has the least amount of ‘red tape’ surrounding it. The only requirement is to inform HMRC of your business. Once that is done, you can start trading right away.||DECISION MAKING – Although I’ve included this in advantages, it can also be a disadvantage. As you make all the decisions, there is nobody to fall back on for help, or to blame if the wrong decision is made. The success or failure of the business rests on you. This can lead to a build up of pressure, particularly at the start whilst the business is developing.|
|PRIVATE DATA – Information about a sole trader is kept private. This is not the same for companies.||REVERSE ECONOMIES OF SCALE – Sole traders are unable to take advantage of economies of scale in the same way companies and larger corporations, who can afford to buy in bulk. This can lead to being charged higher prices for stock which may be reflected on to your customers.|
|ACCOUNTS – As a sole trader all you are required to complete is a profit and loss account. Subsequently, accountants’ fees are usually lower than for completing company accounts.||IF YOU DON’T WORK, YOU DON’T MAKE MONEY – This speaks for itself. If your business is closed, there will be no customer purchases. If there are no purchases, the business is not making money.|
|WORKING HOURS – As a sole trader, you decide when you want to go to work. If you decide you want a day off, you can take it. It has been said that the best part of being a sole trader is having the freedom to strike the perfect balance between work and social life.|
A partnership is where two or more people carry on business together. For tax purposes they are treated the same as sole traders in that the profits and losses are subject to income tax via each partner’s self-assessments each year.
Generally, each partner has equally responsibility and authority to run the business (unless stated otherwise in a partnership agreement) and the actions of one partner can bind the entire partnership.
Although not a requirement, most partnerships have a detailed partnership agreement setting out a range of terms of the partnership. This includes, how the business will be financed, which partner does what work, what happens if one partner dies and what happens if one or more of the partners wants to dissolve the partnership.
You can find out more about Limited Liability Partnerships here.
|CAPITAL – As with a sole trader business, a partnership cannot sell shares in the business in order to raise funds to set up the business. However, with a partnership there are at least 2 people to contribute towards that initial start up fees. The more money that can be put into the business allows for better flexibility and more potential for growth. This in turn should hopefully lead to more potential profit.||TAXATION – Partnerships are taxed in the same way as a sole trader. Each individual partner pays income tax on their share of the profits. This can be a disadvantage as partnerships usually have bigger profits than sole traders (due to the higher amount of capital first invested). This can lead to big tax implications for the partners.|
|LESS RED TAPE – Setting up as a partnership is generally quite easy. Much the same as for a sole trader, the only requirement is registration with HMRC.||JOINT AND SEVERAL – Business partners are jointly and individually liable for the actions of the other partners. If one partner makes an error, or gets the business into debt, all the partners will be liable for that debt.|
|KNOWLEDGE – A partnership may benefit from the combination of complimentary skills of the two or more partners. There is a wider pool of knowledge, skills and contracts. Different partners can specialise in different aspects of the business.||DISAGREEMENTS – Perhaps an obvious disadvantage of a partnership is the danger of disagreements between partners. One partner may feel that their idea is ‘better’ about a decision or how the business should be run. This can lead to disagreements that can harm both the business and the relationship of those involved.|
|FLEXIBILITY – Partnerships are quite flexible in terms of management. There is no interference from shareholders. You only need agreement from the other partner/s.||UNLIMITED LIABILITY – As with a sole trader, the partners of the business have unlimited liability for the losses and debt of the business. Although this liability could be split between the partners this could still be a large amount. This could lead to losing your home, personal savings and any assets within or outside the business.|
|SHARED RESPONSIBILITY – The pressure and weight of running the business does not rest on one person’s shoulders. It is shared equally amongst the partners. Rather than splitting the management and taking an equal share in each task, each partner may take on the full task that they excel at. For example, if a partner is particularly good at figures, they may deal with the book keeping. Whereas another may be good at sales and so deal with that aspect of the business.||PROFIT SHARING – The profits of the business are shared equally between the partners (unless stated otherwise in the partnership agreement) This can lead to issues if one partner is not putting as much effort into the running of the business as others but still getting the benefits.|
|DECISION MAKING – As there is more than one person making decisions, the partners of the business can help each other out when necessary. Each partner can bring something different to the table and these can be moulded together to achieve the best outcome for any problem the business may face.||DECISION MAKING – When decisions are made, all of the partners will need to agree in order for things to be done. This reduces the flexibility of the management of the company slightly, particularly to sole traders. However, this is still greater flexibility than with limited companies.|
Private Company Limited by Shares
The biggest difference with a company from the other mediums is that they have their own legal identity. This means that the company’s finances are not linked to your personal finances. The company is responsible for its own debts and liabilities but also keeps any profit it makes (after payment of corporation tax). A company can then pass these profits on to its shareholders through payment of a dividend. However, this is not compulsory, but it is the only way to personally benefit from the profits of the company.
The day to day running of the company is done by directors (which can vary from one director to quite a few) but any major decisions must be approved by the shareholders (again this can vary from just one shareholder to hundreds). Shareholders are able to purchase shares in order to raise capital to put back in to the company.
A private company limited by shares must be registered with Companies House and can involve quite a bit of paperwork and cost.
|LIMITED LIABILITY– By far the biggest advantage of setting up your business as a private company limited by shares is that each shareholder is only liable for the amount unpaid on their shares. This is For example: if you had 10 shares at a cost of £3000 and you have so far only paid £2000. If the company fell into difficulty, your liability would only be £1000, even if the company had debts of £100,000.||CONTROL – Although a company has directors who deal with the day to day running of the company, any big or important decisions have to be approved by the majority of the shareholders. This can be difficult to achieve, particularly when there are a large number of shareholders.|
|CAPITAL – A company limited by shares can increase its share capital and allot these new shares in order to raise money that can be put back into the company. This makes it a lot easier to finance than a sole trader or partnership who have to use their own money to fund the business.||RED TAPE – Setting up a company limited by shares involves a lot of red tape and is covered by strict registration rules. It must be registered with Companies House which costs £15. There is also quite a lot of paper work to be completed that is quite detailed.|
|STATUS – A professional and corporate image is created by setting up a private limited company. This can boost the value of the business as bigger corporations and industries are likely to do business with a company rather than a partnership and particularly with a sole trader. This is because private limited companies are considered to be more established, credible and committed.||PRIVACY – The accounts of the company, as well as the names of the shareholders and directors and also the directors’ personal addresses are all in the public domain
Dividends – Dividends are payments made to shareholders each year out of the profits the company makes. Although these are not compulsory, if the business is making large profits yet not paying dividends, questions will be raised. Unlike for a sole trader and partnerships, profits do not go directly to you. Once dividends are paid, any surplus profit is reinvested into the company.
|CONTINUITY – The company is not affected by a change of shareholder or director. The company will continue regardless. It is not affected by the death either a shareholder or a director. The only way a company can cease is through liquidation, administration or winding up.||TAXATION – Taxation for a limited company is complicated. A private limited company has its own separate legal personality and so tax is not paid via income tax as it is for a sole trader or partnership. Instead, a company pays corporation tax which can be complicated. This can lead to higher accountancy fees. Each shareholder will still have to pay income tax on any dividend they receive each year via self-assessment.
Not sure which business medium is right for you? Why not contact the Student Law Office to see if we can help?
This post was written by Abbie Swales. Abbie is a final year MLaw student at Northumbria University who currently works in a Business and Commercial Firm with the university’s Student Law Office. After graduating from university, she hopes to obtain a training contract within a commercial law firm. Outside of university, she enjoys watching Formula 1, baking and spending time with friends.