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Getting the fundamentals right

Before starting any business, there are some key decisions to make such as the business form, ownership structure and capitalisation. While these can be changed later, it is worth understanding the implications and setting the right framework from the start so that you can focus on what really matters - making your business a success.

Company, partnership or sole trader?

One of the first questions facing any entrepreneur is the business form you will choose. The majority of businesses are incorporated and setting up a company in the UK is both quick and cheap: the whole process can be done online in half an hour or so.

It may be quick, but it’s quite a fundamental decision. Before assuming that a company is the right answer, it is worth taking time to consider the pros and cons.

What is a company?

The records of companies in the UK are kept by Companies House, which charges £12 for first registration and £13 to file the annual ‘confirmation statement’ that all companies are required to make.

Up-to-date list of Companies House fees

The key feature of a limited company is that it is legally separate from its members. In other words, it has its own legal personality – a company can enter into contracts, make payments, own property and even be a director of another company. This is an incredibly useful invention – imagine if a hundred people had a stake in a business and each of them had to sign every contract.

The liability of the members is limited (hence the name) and in most cases this limit is the value of the share capital that they put in at the start. This is an important protection for entrepreneurs if things go wrong. Most companies are limited by shares and the members are known as shareholders; there are also companies limited by guarantee whose members are guarantors. The guarantee is usually for a nominal sum, such as £10.

A limited company may have only one member (who may also be the sole director). Even in this case, the owner and the business are still seen as individual entities in the eyes of the law. The single member may ultimately own the company, but she cannot simply take money out of the business. She must either take salary as an employee or the company must declare a dividend (a distribution of profits).

Sole traders and partnerships

A sole trader is sometimes described as ‘self-employed’ and is a person carrying out a business in their own right. This is a simpler arrangement, with no separate legal entity and none of the requirements of being a director. The sole trader is responsible for their business assets and debts just as they would be for their personal finances.

A similar principle applies to partnerships, where the partners are jointly and severally liable for any debts. In other words, if one partner creates an obligation (by ordering some materials for the business, say, or signing a lease on a building) then all the partners are equally responsible.

For most commercial businesses the choice is between a limited company or unlimited liability as a sole trader or partner. There are also unlimited companies and limited liability partnerships (and additional business forms such as cooperatives) which are outside the scope of this article.

Which should I choose?

The larger the business and the more people are involved, the greater the advantages of a limited company. Limited liability is a valuable protection and you would need a reason to do without. There are some tax advantages to sole trader status and you can always incorporate later on. It’s generally easier to go from sole trader to company than the other way around.

Here are three independent views:

Record-keeping and planning

It is often said that companies have more stringent requirements for record-keeping. While this is true, having a clear business plan and knowing where you stand is important for your business to thrive – and essential if you are planning to seek external finance. In other words the information needed to file company accounts should be readily available in any business. There are reasons to consider sole trader status, but the need for good record-keeping should not be one of them.