Business structures and their effects
The main types of business structure are sole trader, partnership, and company. Your choice will affect your admin burden, tax, and legal status.
If you don’t choose a business structure
If you don’t choose a structure when starting a business, you’ll be assumed to be a sole trader. That’s how a lot of people start out. However, it’s worth understanding what it means to be a sole trader, and getting your head around the other structures. Speak to a lawyer or accountant before making any changes.
What is a sole trader?
A sole trader is a single-owner business. It doesn’t have to be a single-worker business, so you can hire staff.
Advantages of a sole trader
It’s easy to set up as a sole trader and tax is simple. You just declare income on your personal tax return.
Disadvantages of a sole trader
A sole trader doesn’t have any special legal status, which means the owner is personally responsible for what the business does. If the business gets into debt or legal trouble, so does the owner. Your choice of insurance becomes very important. A sole trader may also miss out on some tax advantages that come with being a company.
What is a partnership?
A partnership is owned by two or more people. There are no rules about how it’s divided. One partner can own 99% of the business. You need to choose a ‘nominated partner’ who is responsible for managing the partnership’s tax returns and keeping business records.
Advantages of a partnership
It’s easy to set up as a partnership, though it’s recommended you have an official document that sets out the agreement between partners. Tax is simpler too. You just declare your share of business profits on your personal tax return.
Disadvantages of a partnership
If the business gets into financial or legal strife, the partners do too. You could also get into difficulty if one of the other partners does something wrong. A partnership may also miss out on some tax advantages that come with being a company.
What’s in a partnership agreement
A simple business partnership agreement should:
- state the legal name of the partnership and say what you do
- name the partners and show their individual profit shares
- appoint a ‘nominated partner’
- say when and how income is distributed among the partners
- include a process for resolving disputes
- identify how bookkeeping and finances will be managed
- outline how the partnership can be wrapped up (and how debts or profits would be distributed)
As you can imagine, even a simple business partnership agreement can get lengthy and complicated. Search the internet for examples or, better still, ask an accountant or lawyer to help.
What is an LLP (limited liability partnership)?
A limited liability partnership is owned by two or more partners, and offers more legal protections.
Advantages of an LLP You don’t necessarily get into legal or financial trouble if one of your partners makes a mistake. Your accountant or a lawyer can give you the lowdown. Business income can be simply dealt with on your personal tax return.
Disadvantages of an LLP It can be more expensive to set up and you have to comply with partnership and corporate laws so admin isn’t easy. It can also be more difficult to get outside investors as they won’t have the same asset protection they would with a company.
What is a company?
A company is legally separate from its owner (or owners), which means you’re less exposed to legal or financial issues. A company can be owned by one person or many.
Advantages of a company
You get some legal and financial protection if things go wrong – your accountant or a lawyer can give you the lowdown. Shareholders may be paid in the form of dividends allowing you more control over your personal income from the company each year. This gives you more options for lowering your tax bill. You can also sell shares in your company to raise money.
Disadvantages of a company
It will cost you more to operate as a company than as a sole trader or partnership. There’s also more admin. You’ll need to know how the company will operate before you get started, and you’ll have to regularly submit paperwork to Companies House.
You can change your business structure
You’re not locked into one structure forever. A lot of businesses start out as sole traders or partnerships and grow into companies. You might change your business structure if you start getting bigger and doing more complex projects which carry a greater financial or legal risk for you.
Where do franchises fit?
If you buy into a franchise, you don’t automatically become part of their business. You form your own business and enter into a deal with the franchisor. You may be able to choose your own business structure, or the franchise agreement may require it to be set up in a specific way, such as a company.
Xero does not provide accounting, tax, business or legal advice. This guide has been provided for information purposes only. You should consult your own professional advisors for advice directly relating to your business or before taking action in relation to any of the content provided.
How to start a business
Thousands of new businesses open every day. If all those people can do it, why not you? Here’s what to do, and when.
- How to do market research
Your business idea is clearly inspired. But it helps to check you’re not the only one who thinks so.
- How to write a business plan
Writing a business plan will help nail down your idea and give you a blueprint for executing it.
- Budgeting and forecasting
It’s time to run some numbers on your business idea. Budgeting and forecasting help with that.
- Pricing strategies and cost of goods sold
Your prices can influence the number of sales you make and the profit you earn on each transaction.
- Types of business structure
Your business structure can affect how much tax you pay, and how you're treated by the law.
- Small business accounting
If you’re starting a business, then you’ll need to get familiar with some accounting basics.
- Registering a business and other admin tasks
After all the excitement of deciding to start a business, you’ll have some paperwork to do.
- How to create a business website
Treat your website like an online version of a storefront. It’s the first impression for many customers and prospects.
- Tools and guides for your business
Now that you’re in business, you want to stay there. Xero’s got resources and solutions to help.
Download the guide to starting a business
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