Different Company Formations

When starting your own business, company formations is one of the most important things to consider, i.e. how the company will be legally structured. You can either be Self-employed or form a limited company and register with Companies House.

Self-employment offers the flexibility of operating as a sole trader or entering into a partnership with one or more individuals. Opting to work as a sole trader is the simplest form of self-employment, allowing individuals to run their business as an individual entity, making them solely responsible for the business’s success and debts. On the other hand, forming a partnership involves collaborating with others, sharing profits, responsibilities, and the burden of any debts the business incurs equally or as agreed in the partnership agreement.

Company Formations – Sole Trader

Becoming a Sole Trader is the most straightforward business formation to run and set up. It is easier to set up records and accounts. You are responsible for making any decisions. You will also be responsible for any debts caused by the business. It means that your own personal assets, including your home, may be at risk if the business runs up debts.

As a sole trader, you must complete an annual self-assessment and keep accounting records of your business income and expenditure. Profits on a sole trader are taxed as income. You must pay Class 2 National Insurance Contributions and Class 4 contributions on any business profits. We have developed a self-employed tax calculator to determine how much tax and National Insurance you will pay.

If you are self-employed, you must register with HM Revenue and Customs.

Partnership

A partnership is a business structure where two or more individuals establish a company. Each partner must register as self-employed in this arrangement, ensuring they are individually recognised for tax purposes. It’s highly advisable to have a written agreement prepared, preferably with the assistance of a qualified solicitor. This agreement should outline each partner’s roles, responsibilities, and profit-sharing arrangements to prevent future conflicts.

The partnership and each partner must make self-assessment returns and keep records of the business’s income and expenditure. Each partner takes a share of the profits and will be required to pay Class 2 National Insurance Contributions and Class 4 on any share of the profits.

In a partnership, you are responsible for any debt run up by the business. If the business gets into trouble, each partner is liable for the debt in the business. If one partner cannot pay, the other partners are legally responsible for making up the shortfall.

Company Formations – Limited Liability Partnership

A Limited Liability Partnership is formed when two or more partners set up a business. A partner can either be an individual or a company. In an ordinary partnership, you share the risks and profits. In a Limited Liability Partnership, the risks are restricted to the amount of money invested and any personal guarantees used to raise finance. A written agreement should be drawn up with a solicitor.

Limited Liability Partnerships must be registered with Companies House and file annual accounts, for which a fee is payable. The LLP and each partner must make self-assessment returns.

Each partner takes equal shares of the profits unless the written agreement states otherwise. If the partner is a company, the company pays Tax and NI according to its business structure. An individual will pay income tax and NI, and a Limited Company will have to pay corporation tax.

Limited Liability Company

Limited Companies exist in their own right, so the company’s finances are distinct from the personal finance of the owners. The shareholders can be either individuals or other companies. Limited Companies must be registered with Companies House and have at least one Director and a Company Secretary. Money is raised by shareholders, borrowing and retained profits.

There are two main types of Limited liability companies:

In private limited companies, the shares cannot be offered to the public, but they can have one or more shareholders.

Public Limited Companies (plc), shares can be offered to the public. The share issue must be at least £50,000 before it can trade. There must also be at least two shareholders.

In both instances, accounts must be filed with Companies House, and an annual return must be completed. Profits are paid out to shareholders by dividends. Companies pay corporation tax. Company directors must pay Class 1 National insurance and tax on their salaries.

There are companies that can complete the company formation process for you. It usually will only take a couple of days to complete.

Why Form a Limited Company?

There are some advantages to forming a limited company rather than being self-employed. We will look at each.

Limited Company – Separate Legal Entity

When a new limited company is created, a separate legal entity is incorporated at Companies House. That Legal entity has to meet specific commitments, including completing an annual company return and filing accounts each year.

If a limited company goes wrong, the only money a shareholder or director will owe is restricted to the amount they paid for the shares unless credit has been secured on a personal asset or guarantees.

Limited company and credibility

In running your business, it may be easier to get new customers by forming a limited company. It may feel to customers that it is a much bigger company. Some of the larger companies will refuse to deal with self-employed people, so it is worth looking at your type of customers to help make the right decision.

Costs involved

There are certain costs involved in forming a limited company. You will need to pay for the company to be incorporated at Companies House, pay a filing fee for the annual return and arrange for an accountant to prepare the year-end accounts to submit to Companies House. You can complete year-end accounts, but there are strict rules; if they are not completed correctly, they will be returned.

Taxation

There are different taxes involved in running a limited company to being self-employed. If you are planning a small business with little profit, registering as self-employed may be cheaper. If you are planning a large company, it may be more affordable to be a limited company. You must review all the tax implications to confirm the best choice for your business.

VAT registration

As a partnership or self-employed, you can register for VAT. Therefore, this does not need to be considered when making your decision.

Pension Costs

As a limited company, you must set up a pension scheme if you employ staff. Both the employee and employer can contribute to the scheme.

Exit Strategy

If you plan to expand the business and then sell it, it may be easier to do this as a limited company. The company owns all the business assets, employees and products. It is far easier to see what the business owns.

Deciding which identity your business will take can be one of the most challenging decisions if you are not sure it may be worth starting as self-employed. If the company is successful, you can then form a limited company.

If you are unsure of the best company formation, request help from your local tax office or Business Link.