There are all kinds of business models, but only three basic types of businesses. These are sole traders, partnership and limited companies. Each one has its pros and cons. Here’s a quick guide to what you need to know.
As a sole trader, you literally are your business and your business literally is you. This makes the administration about as easy as it can possibly be. Essentially, all you have to do is register with HMRC as self-employed. You can use your personal bank account and credit card to receive business funds and make payments. Your business income is taxed as regular income.
Working as a sole trader is a great option for many freelancers. There are, however, two potential issues with it. Firstly, it lacks the flexibility of working as a limited company. Secondly, it can be very difficult to scale up as a sole trader.
At a basic level, all partnerships are essentially two or more legal entities working together. Typically, these legal entities will be individual sole traders. In principle, however, limited companies can be included in partnerships.
In the UK, the main types of partnerships are:
General or ‘ordinary business’ partnerships
Limited liability partnerships
With general partnerships, partners are wholly and severally liable for each other’s debts. With limited liability partnerships, each partner’s liability is limited to the amount they put into the business. Limited partnerships have a mixture of general partners and limited liability partners. For completeness, the rules on limited partnerships are slightly different in Scotland.
Limited companies – the basics
Limited companies also come in two main versions. These are regular limited companies and public limited companies. Public limited companies are limited companies that are listed on at least one stock exchange. This requires them to publish certain details about their operations, such as the state of their finances. Regular limited companies do not have to do this.
With a limited company, the company itself is a legal entity in its own right. This has significant implications for how it is managed. In the short term, it can produce challenges you might not have encountered working as a sole trader.
For example, you will have to build up a credit record for your limited company itself, rather than just using your own. In reality, there is a bit of nuance here. For example, in the early days, you may act as a guarantor for your limited company. Effectively, therefore, you will be leveraging your own credit record.
You’ll also have to deal with the different requirements for paying tax. For example, your company’s income will be subject to corporation tax. Any wage/salary you take from it will then be subject to income tax. You may also choose to take dividends. These will be subject to dividend tax.
Limited companies – the advantages
All this may sound like a lot of hassle. The truth is that it can be. For some people, however, the administration can be more than justified by the potential gains. There are two key advantages to operating as a limited company compared to operating as a sole trader.
Firstly, you have much more control over how you take your income. Secondly, any liabilities taken on by the business generally stay with the business. There are a few potential exceptions to this, but they are very much the exceptions rather than the rules.
Thirdly, you can transfer all or part of the company to new owners. For example, you might elect to give your children part-ownership in the company during your lifetime to reduce the IHT liability on your estate. You could then sell the rest of your stake when you wanted to retire.
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