A guide to business entities

Know your options when it comes to setting up your new venture...

  • Go for it!

    You’ve decided to go for it and launch your idea, but the different types of business entities seem so terribly complicated.

    Business entities are not hard to understand, but there is a little thought required if you want to make a decision that’s right for you and your circumstances.

    The structure you choose is dependent on a number of personal and accounting preferences. But what’s important at this stage is that you make a decision on your business entity at the outset, before you start to trade.

    Your choice of entity may have some legal implications that you need to take care of too. So it’s worthwhile getting some professional advice before you commit to choosing one entity over another and ploughing full steam ahead.

    There are three primary options for you to think about, which we’ll explain further as the guide progresses. While the aim is to provide you with all the information you need to make an informed decision, the final say can only be yours.

  • Sole Trader

    Working as a sole trader is a term you’ve probably heard an awful lot. What that actually means is that you’re working for yourself and trading under your own name - or possibly a ‘trading as’ or ‘T/A’ name. You don’t need to register your business name if you’re a sole trader either, but you do need to register your business with HMRC.

    Here’s a text book definition to describe someone who is a sole trader:

    ‘A person who is the exclusive owner of a business, entitled to keep all profits after tax has been paid, but is liable for all losses.’

    So how does the ‘money’ aspect work as a sole trader?

    As a sole trader you get to keep the profits you make. As a general rule profits means your total income less any allowable expenses and taxes. You are responsible for settling any financial losses that your business incurs too.

    It’s a quid pro quo really, because while you get to pocket any profit, you’ll also have to dig deep into your waders and pay any money owed that’s related to your sole trader business activities.

    You’ll be required to keep a detailed list of your income and a comprehensive spreadsheet of your legitimate business-related outgoings too.

    On top of that you have a legal requirement to register your business (within three months of trading) and complete an annual Self Assessment return through HMRC. You can either do this yourself or pay an accountant to do for you (it may be useful to source the services an accountant who will keep you right). You'll also have a duty to settle your own National Insurance contributions, which are either Class 2 or Class 4 and profit dependent, and understand your tax and VAT liabilities (which is why a qualified accountant may prove extremely useful!).

    In terms of keeping business monies entirely separate from personal monies, it would be wise to open a dedicated business bank account that you’ll use to pay in and withdraw funds. 

    Tip: When you’re applying for your business bank account be very clear about the name(s) you document on the application form. If you don’t and you receive a cheque that’s payable to any name bar the one that’s on your new business account, you’ll find yourself in a position where you are unable to pay the cheque in as the payee name won’t identically match the name on your business account. 

    Summary: Setting up as a Sole Trader means that you can work for yourself and you can work for someone else at the same time. It means you are responsible for running your business and reporting accounting figures. You’re also liable to cover any debts that your sole trader business incurs as a result of your trading activities. It’s down to you to report all of your business trading figures through an annual Self-Assessment return too.

  • Partnership

    Let’s explore the possibility of going into partnership with someone. We’ll assume (as you’ve already set to the task of getting build quotes for your amazing product) that someone you’ve been liaising with has been so impressed with your idea, they want to do business with you. They’ve want ‘in’ and have agreed to meet any associated costs with getting your idea off the ground, on a 50/50 share, and are prepared to formalise an official partnership agreement.

    On the basis that you are not going down the ‘Limited Company’ or ‘Limited Liability Partnership’ route, again there’s absolutely no requirement for you to register the partnership name that you (or both of you) choose.

    When you’re setting up the partnership, it would be advisable to take the following steps as a minimum:

    • Ask an independent solicitor to draft a legal contract which determines the financial parameters and roles and responsibilities of each business partner by putting together a formal Partnership Agreement
    • Register your business partnership with HMRC as soon as you can and be sure to do this within the correct timescales
    • Decide who the ‘nominated’ partner is (nominated means the person who is responsible for submitting all financial information to HMRC) and include this information in your Partnership Agreement
    • Register for VAT (see HMRC's VAT Limits)
    • Set up a business bank account for your partnership, assuming you’ve decided on a name*
    • Procure stationary items like headed paper, compliment slips and business cards

    *Business names can have some restrictions. Make sure you’re not including a word that is classed as ‘sensitive’ or that requires government approval.

    Once you’ve got a handle on the administrative issues, you’ll find that working in a structured partnership has some real advantages. You may have chosen your business partner on the grounds of the skills they bring to the table or their financial contribution. Perhaps the vast sea of contacts they have or that they speak fluent Mandarin, which is perfect seeing as you’ve got the best build quotes from a factory in Shenzhen, China! 

    Tip: When you’re setting up your business bank account give some thought to the level of access each partner will have. You should be given a choice over whether to have access on either of the following terms, referred to as Dual or Single authority:

    • Dual authority banking means that both business partners have to sign cheques, authorise online banking payments and are required to agree and electronically sign for things like direct debits and standing orders. Having both business partners on a ‘dual’ mandate keeps things extremely tight in terms of the movement of money: one partner will not be able to make any withdrawals without the other partner’s approval. Dual authority is there to protect your money and offer you peace of mind by restricting who can access it. Not all transactions will be covered by a Dual mandate, though, so check with your bank over what you can and can't do.

      It can also be annoying if you have to wait for your partner to return from a week’s holiday, while the outstanding invoices awaiting approval stack up. So be mindful of the timescales you need to work to and try to plan ahead.
      It is important to note that a debit card is normally one to sign. Think of the example of withdrawing money from an ATM, it only requires one card holder and one PIN. Therefore you may need to set limits on how much each partner can withdraw, or get credit cards for each partner.

    • Single authority banking means setting your business account up on the basis that either partner can have full and unlimited access to the account at any time, which can involve, for example, moving and withdrawing money, setting up new payments and signing cheques, with just one signature required. It can offer real convenience and a fast turnaround if you’ve a lot of invoices to settle, but it can be a risky strategy too. Not just on the grounds of trust, but on the grounds of potential misuse, disorganisation and poor money management. So if you think you’re the type of person who’d lie awake all night wondering about your working capital and where it is, talk your concerns through with your business partner and see if you can both agree on a suitable outcome.  While one option delivers a level of convenience, it may also present a level of fraud risk too. 

    Summary: Setting up a 'Partnership Agreement' means that a minimum of two people are required to kick start the business. It can be a real asset if you and your partner have complementing skills and can each work on different key deliverables. But it can be a weakness too if you can’t agree on major decisions, such as: business direction, marketing spend or whether to trade internationally or domestically.

    In terms of partnership debts (and depending on your legal agreement), you’ll generally have what’s called joint and several liability. This means that, whichever way you look at it, one or the other partner is wholly liable to settle any monies owed as a result of business debt that has arisen from the trading activities linked to the partnership.

  • Limited Company

    Setting up a limited company can seem really confusing, but that’s primarily down to a lack of understanding of what a limited company is. It can all seem a bit of a minefield, but it’s really not.

    Going down the limited route means that you and your business will be two completely separate legal entities. There are a number of tax and financial implications to setting your business up as a limited company and you should seek professional advice to determine if this is the best option for you and your business.

    The rules that apply to limited companies are different than those which apply to sole traders and unincorporated partnerships. There’s corporation tax to pay (depending on your business profits) and you may even decide to pay dividends. Plus your accounting fees may be a little more costly given that the annual (and interim) accounting can take more time compared with completing a sole trader Self-Assessment once a year.

    For more information on the rules associated with limited companies check out the Accounts and Tax Returns for limited companies on HMRC’s official website.

    On a positive note, there are many organisations who prefer to deal with limited companies and who deliberately avoid working with unregistered businesses like sole traders and unincorporated partnerships. It can potentially open doors when it comes to securing contracting work or submitting applications for bids and tenders.

    We’ve outlined some of the steps you’ll need to go through if you want to go down the limited company route. If you follow these steps and refer to HMRC’s guidelines, you shouldn’t find it too much of a challenge.

    How to set up a Limited Company:

    1. Choose your company name by checking out the available names on the official Company House register
    2. After selecting your name, input your Limited Company’s registered address
    3. Appoint the director(s) and/or shareholder(s) linked to your company
    4. Decide the level of shares that each director or shareholder will hold
    5. Complete the Memorandum and Articles of Association (sounds complex but either follow the guidelines and use HMRC’s standard wording, or speak to your accountant or solicitor to draft your own)
    6. Once you’ve completed the above steps, have your credit card handy to pay the small registration fee

    There are many organisations, including accountancy practices that will complete this application for you, for a one-off fee.

    After your business has been successfully registered you’ll receive a Certificate of Incorporation – a legal document that confirms the formation of your company. You’ll also be sent regular communications from HMRC advising when you should file your first accounts, annual accounts, pay Corporation Tax and file your official annual Company Tax Return. 

    Summary:  Setting up a limited company will take a little bit of work. You’ll need to register, file an annual Company Tax Return, as well as pay Corporation Tax on any profits, and understand that your company accounts can potentially be seen by anyone: a Limited company’s accounts can be accessed by any member of the public, so be mindful of this if you enjoy utmost privacy. There may be, however, some real advantages in terms of tax, so be sure to speak to a qualified tax or accounting professional who can talk you through your options and help you make an informed choice before you commit to anything.


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