Starting a business, such as an SME, can be quite daunting. One of the first decisions to make is what type of business you will be.
The main options open to you are:
- Sole trader
- Limited company
You should seek advice from professionals before undertaking any decision relating to your future business.
The following outlines the principal characteristics for each legal status.
Sole Trader / Self Employed
A sole trader is the most common way to start a business, being very straightforward to set up.
A sole trader is a business owned and run by a single person, possibly employing others, but the risks belong to the individual owner. Legally, you are recognised as ‘being the business’.
If the business fails with debts, you will be personally responsible.
You should register with the Inland Revenue as soon as you begin as a sole trader (and no later than 3 months after starting to trade) because there is a fine of £100 imposed if you do not.
You will also need to check things such as insurance and whether using your house and car, for the purposes of your business, are covered by the policy, for example.
You must remember that any profits that you make as a sole trader are taxable and that you have to pay National Insurance (Class 2 NIC’s at a weekly rate of £2.30 in 2008/9 and £2.40 in 2009/10) if the earnings exceed the lower earning limit (£4,825 in 2008/09 and £5,075 in 2009/10). Class 4 NICs are also paid in addition to Class 2 NICs by self-employed people who make a profit over a certain limit in the tax year – this limit is set at £5,435 in 2008/09 and £5,715 in 2009/10). Self-employed people declare their profits annually on a self-assessment tax return.
Similar to a sole trader, however, the responsibilities, costs and profits are shared between two people or more – the partners – and as such, a solicitor should be used to create the agreement before you go into business together.
It has no legal status, but rather defines two or more self-employed people in a business organisation.
A partnership, particularly where money is involved, can suffer tensions, so you should involve a solicitor at the outset so that any later ‘split’ can try and be civilised.
A limited liability partnership (LLP) provides members with lower liabilities for any debts incurred whilst the enterprise is in operation.
A limited company is legally a ‘separate body’ from its owners, who are therefore not personally responsible for its debts unless the directors have guaranteed a business loan for example. A limited company can have tax benefits and owners and employees receive a salary.
Shareholders will own the company but do not need to be involved in helping to run it and may or may not receive dividends from the compaany.
The shareholders appoint directors to run the company, who in turn are responsible to the law – and shareholders – for the way it operates. Directors can also be employees of the company.
A limited company has to be registered at Companies House. A chartered accountant or solicitor for example, can set one up, or you can buy a firm that has already been created.
A limited company has its own obligations, including the need to provide financial statements. Auditing is not required for smaller firms until turnover or assets reach a certain value.