4. The legal structure of the business

Sole trader

If you’re unattached, becoming a sole trader is the obvious answer when you’re setting up a new small business. It’s straightforward from a legal, tax and accounting point of view. It also means you’re answerable to no-one. What you earn is yours – after everyone from the Inland Revenue to the window cleaner has been paid, of course. Policy and strategy meetings are a breeze!

If you trade under a name other than your own you are required to display your name and address at your premises and on stationery.

Partnership

If you are married or in a relationship then you could still operate as a sole trader if your other half isn’t going to be involved in the new venture. However, forming a legal business partnership to underpin your new business is an attractive option from a variety of angles and is something which many couples do. The degree of involvement of a partner can be very small. It could be the odd bit of book-keeping or an occasional trip to the cash and carry. Equally it could be full 50% participation in all aspects of the business. Your accountant will prepare accounts which split profits in the most financially advantageous way.

• It is no bar to being a partner that somebody is in full- or part-time employment elsewhere.
• It is normal and desirable to have a written partnership agreement which your solicitor can prepare. Though not a legal requirement your bank may well insist on it.
• There can of course be tax advantages to a couple entering into partnership. For instance, when the income of the business is attributable to an individual it might attract tax at the top rate whereas it may well not if split between two partners.
• On a more general note it seems appropriate that two people involved in a venture should each have a financial stake in it. Hopefully it will become a progressively more valuable asset as the years go by.
• In the event of divorce each partner’s share of the business will be simpler to assess.
• By setting up a partnership you are creating a legal entity which your children can join in the future if you and they wish.

This liability is one reason why, if you ever consider bringing one of your children or anybody else into the partnership, that person should be given detailed financial information about the business to enable them to make a fully informed choice. There are some circumstances where a new partner could be responsible for pre-existing debts. Prospective new partners should be told to obtain independent legal advice (yes, even your children) before being expected to make any kind of commitment.

The names of the current partners together with an address where documents can be served should be displayed on your headed paper or at your business premises.

Limited company

Experience and professional advice have led me to the view that it is not a good idea for someone starting out in business to do so by means of forming a limited company. For a start, it involves more bureaucracy than being a sole trader or being in partnership.

For instance, you have to prepare annual accounts and annual returns which must be lodged with your local Companies House. Failure to lodge accounts on time can constitute a breach of the criminal law. Do you really need this extra pressure at a time when you will have so much else on your mind?

There are certain benefits which do accrue to company directors – company cars for example – but these have come under close scrutiny by the Chancellor in recent years. It is true that there is limited liability in the event of business failure. However when setting up the finances for your new venture your bank will protect their loan to you by taking a legal charge (in Scotland a standard security) over the business premises or your house or by means of a personal guarantee. There’s no escaping them!

Incorporation is best considered later on, if your operation expands considerably. This is the stage when the benefits such as more advantageous tax rates are greater.

Setting up a limited company is a specialised area for which good professional advice is essential.

One other point to bear in mind: it is apparently quite a simple legal matter to go from being a sole trader or a partnership to being a limited company – but more complicated the other way round.

A further legal entity has very recently been created called a limited liability partnership. This may be of interest to the small businessperson as being a cross between a partnership and a company. At the time of writing very little information is available. However, as with a limited company, formal registration and the lodging of annual accounts will be necessary, so for the new business sole trader or partnership is probably still best.

Franchising

In simple terms becoming a franchisee involves paying somebody else for the right to use their concept. The advantages are fairly obvious:

• You will enjoy the immediate commercial benefits of trading under a well known, tried and tested brand.
• You will receive (certainly in the case of the bigger internationally known brand names) professional advice and support from an experienced management team for setting up and running the operation.

However, there are a fair number of disadvantages:

• High start-up costs. Take the case of one currently prominent franchisor of sandwich bars as an example. The total capital requirement in April 2002 of buying the equipment, fitting out a shop, architects’ fees and so on was estimated to be between £72,650 and £140,250 depending on the particular unit you obtain. Serious money. What’s more, although the franchisor in question says that they might be able to help with financing, you the franchisee would have to come up with between £6,325 and £70,125 from your own resources. You might, of course, get a more favourable deal from another bank but it’s a lot of money to lose if things don’t work out.

Bear in mind also that these figures are based on leasehold premises. They do allow for legal fees and a quarter’s rent but do not include the cost of any premium you might have to pay to acquire the lease. Needless to say, if you want to buy premises this will add dramatically to the costs involved.

• You will need to engage solicitors experienced in this specialised field to advise you on the franchise agreement which will govern your relationship with the franchisor.
• Lack of independence. Basically you have to do things their way. You might be able to introduce the odd bit of fine tuning here and there but you can forget any creative ideas of your own.
• When you come to sell, the franchisor will have the right to vet any potential new franchisees – in the same way as they will have vetted you. In this particular case they also have the right to match the best offer you receive and buy the business themselves. Whilst such terms are not the end of the world they could complicate things and be highly offputting for a potential purchaser at a time when you might be very keen to do a quick deal.

If you are serious about franchising – and this is a route which quite a lot of people follow – you should have a discussion with the franchising governing body, the British Franchising Association (tel: 01491 578050) to get more information. Their web site is www.british-franchise.org.uk. Also try to speak to some franchisees to find out how the experience has been for them. You will probably gain the most valuable insights by doing this. My impression is that they work just as hard as other small business people but sometimes resent the restrictions placed on them when their hard work has paid off and the business is doing well a few years down the line. There are regular exhibitions on the subject of franchising and obviously it would be a good idea to attend some of them in order to help you to decide if it’s for you.

5. Going Into Business With Friends

Is it a good idea to go into business with a trusted friend? (Well it certainly isn’t a good idea to go into business with one you don’t trust!)

There are undoubtedly some advantages.

• You would each bring different areas of experience and expertise to the venture.
• If problems arise they might be resolved more easily with the input of two people who can look at an issue from different angles.
• You could cover for each other to allow the business to continue operating safely when one of you takes a well earned holiday. This is not to be underestimated since a lack of decent holidays is one of the commonest bugbears of small businesspeople.
• Two bank accounts are bigger than one. Accordingly you may well be able to go for better premises with more sophisticated equipment than you could have done on your own.

There are however, undoubted pitfalls as well.

• By it’s very nature a small business is not very big. Unless you and your friend see eye to eye on virtually everything then areas of disagreement will emerge. Even quite minor issues can cause controversy. My wife and I agreed on lots of things without quibble but could we agree on the right colour for the exterior of our second shop? It took weeks of discussion and humming and hawing and was only resolved by one person agreeing to something they were not very keen on. I wonder who?
• You might get on tremendously well with someone and maybe even with their husband or wife, but what about your own spouse or partner? If, say, problems arise necessitating longer working hours and he or she feels that you are taking too much of the strain, might this not generate a lot of tension for your relationship as well as your business partnership?
• If the business doesn’t succeed, with the best will in the world, your friendship will come under great pressure. You will find yourself in the position of having to try to unravel legal, business and financial matters with someone who was previously associated with carefree socialising over a few drinks.

I have known at least two lengthy friendships which foundered in a short space of time after a hotel venture, which the people concerned set up, ran into difficulties. Forewarned is forearmed.

For what it’s worth my own view is that a small business such as a sandwich-coffee bar. especially one just starting up, is not generally big enough to accommodate two sets of people and their myriad ideas. I think it is well suited to husbands and wives but I prefer to keep my friends as friends and not become involved with them financially or businesswise. However, this is only my view and there are no doubt examples of friends successfully going into business together… I just can’t think of any!

Going into business: advice and education

There are government-supported initiatives to encourage, assist and support new business start-ups throughout Britain.

In England contact Business Link, tel: 0845 6009006.

In Wales contact Business Connect, tel: 08457 96 97 98.

In Scotland contact Small Business Gateway, tel: 0845 6096611.

In Northern Ireland contact Business Link, tel: 02890 239090.

Your local Chamber of Commerce will have business start-up advisors who will be able to deal with frequently asked questions on the subject.

Check with local colleges. Some will run courses under the general heading of Business and Finance or Business Administration. Some courses will last a year and will provide a valuable introduction to many of the most important aspects of the business world. Financial assistance for such courses may be available.

In addition, contact your local council. They will almost certainly have details of other small business initiatives which may be of relevance to your situation. However, it is most unlikely that you will receive any form of financial assistance. Rather it will be a case of advice on starting a business or help to locate suitable properties. This could be extremely valuable for the novice. But if you already have experience of running a small business you probably know more about it than they do!

Financial contribution to the venture

How much hard cash should you put into your business? In my opinion there is no specific formula which can be neatly applied to this question. Banks have rules about what percentage they will lend (see page 41 for more information about banks). However, they do have some discretion. If you have a good record and are capable of being reasonably assertive then there is some leeway. In fact I have heard that some managers prefer it if instead of asking, the customer simply tells the bank what he or she wants.

I have known people in business who take the view that maximum pressure should be exerted on the bank to provide as much of a loan as possible. They will tell you that all of the most mega-successful businesspeople in the world have got where they are today by doing this and setting up their businesses ‘with someone else’s money.’ Maybe so, but I’m sure lots of them have made mega losses as well. Anyway does this description relate to you? I doubt it.

It follows that before you are in a position to go after particular properties you and/or your partner will need to have built up some savings. One of the reasons it is important to make contact with your bank at an early stage is so that, amongst other things, you have a clear idea of how much money you will need to contribute.

Given that the bank will want something I think the best answer to the question posed at the start of this section is: as little as the bank will reasonably accept.