Choosing a legal structure for your startup
- 1 December, 2016
- Posted by: Anick Akbar
- Category: Accounting & Finance,
Choosing a legal structure for your company is one of the first official acts you will undertake for your startup.
Most startups are set up as a limited company. But this isn’t your only choice; there are other options which require less administrative work and offer greater flexibility, but can come with higher risks.
It’s a good idea to investigate all your options before making a decision on which legal structure is best suited for your company.
When it comes to choosing a legal structure, you have four main options:
- Sole trader
- Limited Liability Partnership (LLP)
- Private Limited Company (Ltd)
As a sole trader, you run the business in your own name. This means that you and your business are a single legal entity. From an administrative perspective, this is the simplest way to run a business; you don’t need to register with Companies House, the UK registrar of Companies (although you do need to register with HMRC). The downside is that there is unlimited liability upon yourself – if your business collapses, your debtors can come and claim your personal assets to pay off any outstanding liabilities.
A partnership is essentially a sole trader structure but with more than one person. Again, you and your business partners don’t need to register your startup with Companies House and you share a single legal existence with your business. With a partnership, there is an added layer of risk, as you are also liable for the actions or omissions of your fellow partners. Even if it’s not you who’s made a mistake, you can still end up paying for the consequences.
Usually, partners will have a written agreement that sets out how the profits and losses will be shared. The agreement typically also includes rules about how the business will be directed and controlled. This is a private document and does not need to be filed with Companies House.
Limited Liability Partnership (LLP)
This legal structure does exactly what it says on the tin; it’s a partnership but all the members have limited liability. An LLP has its own legal entity, separate from that of the members. It has its own legal rights, own properties and assets and is responsible for its own liabilities.
The extra security of limited liability comes with additional compliance requirements; the LLP must register with Companies House and file its financial accounts annually as well as when other corporate events take place. An LLP does not have any share capital. Instead, members have ‘interests’ in the LLP.
Members generally contribute to the partnership’s assets and share profits according to how much they have put in. As with regular partnerships, the LLP’s governance principles are typically set out in a partnership agreement. This is again a private document and does not need to be filed with Companies House.
Private Limited Company (Ltd)
This is the most common legal structure for most businesses. The company has its own legal existence, completely distinct from its members, who are called ‘shareholders’.
Running the company day-to-day is the responsibility of the ‘directors’. The arrangements of what this entails is written out in a formal agreement known as the articles of association. This is a public document and must be filed with Companies House. Shareholders can also have a separate shareholder’s agreement in place to clarify their responsibilities but this is optional.
If you set up a private limited company, you typically become a director and a shareholder of your company. When the company turns a profit, you can receive this in the form of dividends, which attract less tax and national insurance than a salary would. Investors can be issues shares within the company, entitling them to share in the company’s profit and losses. Their liabilities are limited to the number of shares that they hold.
Overall, establishing as a limited company is the best choice for startups and growing businesses, as it’s the most favourable legal structure when adding/removing people to the company and securing investment.