The Company structure you select for your business is critical. It influences the Director’s personal liability, the ability to raise funding, impacts the liability for tax and the paperwork required. Learn which structure is the best for you, as we review the different types of company structure, and the advantages and disadvantages of each.
Common structures are;-
The legal structure of the company influences the liability for tax, the paperwork your business has to complete, the personal liability for the directors and your ability to raise funding for the business. So this is an important decision.
Sole partner or proprietor, or sole trader
- Limited company
- The limited liability company (LLC)
- Limited liability partnership (LLP).
- Employee ownership
- Not for profit
- Sole trader
The most basic structure is the sole trader or proprietorship, which usually involves just one person who owns and operates the business. You have complete control over your business and make all the decisions.
If you decide to start your business as a sole trader but later decide to take on partners, you can reorganize as a partnership or other entity.
The tax aspects of a sole proprietorship are simple. The income and expenses are included on your personal income tax return. This means that any business losses you suffer may offset the income you have earned from other sources.
The disadvantage is that you are personally responsible for your company’s liabilities. As a result, you are placing your assets at risk, and they could be seized to satisfy a business debt or a legal claim filed against you.
Raising money may be difficult. Banks and other financing sources may be reluctant to make business loans to sole traders, so you will have to depend on your own financing sources, such as savings, home equity or family loans.
If your business will be owned and run by several people, structuring your business as a partnership may be right for you.
Partnerships can be general partnerships or limited partnerships. General partners are liable for all debts and obligations of the company, limited partners can contribute capital and are not liable for debts and obligations over that amount as long as they do not receive back their contribution or take part in the management of the business.
Limited partnerships are more complex administratively; a general partnership is much easier to form.
One of the major advantages of a partnership is the tax treatment. A partnership does not pay tax on its income but passes any profits or losses to the individual partners.
But personal liability is an issue if you use a general partnership. General partners are personally liable for the partnership’s obligations and debts. Unless the partnership agreement forbids it, each general partner can act on behalf of the partnership, and may take out loans and make decisions that will affect and be legally binding on all the partners.
Partnerships are more expensive to establish than sole proprietorships because they require more legal and accounting services.
Corporation or limited company
The corporate structure is more complex and expensive than most other business structures. A corporation or limited company is an independent legal entity, separate from its owners; it has to comply with more regulations and tax requirements.
The biggest benefit for a business that is incorporated is the liability protection. A corporation’s debt is not considered that of its owners, so if you organize your business as a corporation, your personal assets are not at risk.
A corporation can retain some of its profits without the owner paying tax on them. However many banks and finance companies will often insist on Directors offering personal guarantees for business loans.
Limited companies or corporations can be privately or publicly owned.
It is also easier for a public corporation to raise money, by selling stock to raise funds. Corporations do not depend on the involvement of named partners but can continue to trade, even if one of the shareholders retires, dies or sells the shares.
Disadvantages are higher costs, and more complex rules and regulations. You will probably need the services of accountants and lawyers.
Another drawback to forming a public corporation is the tax situation. Companies pay corporate income tax but earnings distributed to shareholders as dividends are taxed as personal income. However salaries and compensation are paid before corporation tax.
A shareholders’ agreement can provide for and deal with other important issues, including:
- board constitution and control of the management of the business
- contributions of each party and how those contributions may be applied
- agreeing and amending a business plan
- terms on which shares can be transferred
- distribution policy
- reserved matters to protect any minority shareholders
- confidentiality and restrictive covenants
- ownership of intellectual property rights
Although these points can be included in the company’s articles of association, most of them will not be included by default on the incorporation of a company, so would need to be amended. The articles of association is a public document and any provisions included would be subject to company law, limiting the scope of bespoke provisions.
The shareholders’ agreement is a private document, enforceable only between the parties. This affords flexibility to tailor the provisions according to personal requirements and circumstances.
The parties’ exit strategies should be considered when drawing up these documents, and may be factored into agreements.
There are several formats:
- The workforce directly own most or all of the share capital
- The share capital held in trust for the benefit of the employees;
- A hybrid of these two formats.
Employee ownership is becoming a popular alternative business structure for start-ups seeking employee commitment, long-established businesses dealing with a succession challenge, or new forms of public service delivery vehicles.
In the UK, employee ownership already contributes more than £30bn each year to GDP. Growing interest in this form of business structure in both the private and public sector led to a 10% increase in the number of employee owned companies created in the UK in 2012.
Economic competitiveness and high performance are a feature of employee owned business, which tend to have higher productivity, greater levels of innovation, better resilience to economic turbulence and more engaged workers than externally owned organisations. Shares in employee owned businesses have significantly outperformed those in the FTSE All-Share Index over the last 15 years.
The implementation of employee ownership can be simple and straightforward. The costs of creating an employee owned business from the outset or achieving an employee buyout are modest compared with other types of company formations or mergers and acquisitions.
Building a structure that creates a genuine sense of ownership amongst employees is one of the considerations when selecting the model.
Other issues to be considered include;-
- How the transfer to employee ownership will be funded
- long term safeguards for employees?
- How will the voice of the employees be heard?
- How will senior managers be free to commercially drive the business, and still be properly accountable to the employee owners?
The sense of purpose and commitment that employee ownership delivers makes this an attractive option. It encourages retention of the very best talent to enable businesses to compete successfully.
A practical guide to setting up employee owned businesses in the UK is published by the Employee Ownership Association.
The non-profit and charity sector
The purpose of the non-profit sector is to improve and enrich society, and create social wealth rather than material wealth. Firms in this sector exists to make a difference to society rather than to make financial profits.
This is also referred to as the third sector, the Voluntary and Community Sector (VCS), the not-for-profit sector, the charity sector, the social sector. It is made up of many different types of activity affecting many aspects of society.
The term, the third sector, indicates that it sits between government (the public sector) and the private or commercial sector.
These companies can exist in a range of formats from social enterprises, trades unions, public arts organisations, community interest companies, voluntary and community organisations, independent schools, faith groups, housing associations, friendly societies, and mutual societies.
They must be registered and approved by the relevant governing body and abide by their regulations. Because they broadly exist for public benefit they are usually eligible for a range of income and property tax exemptions.
Whatever option you choose for your structure, the name you choose for your business should reflect the image you want to project to your market. Select one that’s easy to pronounce and remember. And make sure that it’s not already in use, that it is available as a web address and will work on your business stationery.