3. What Sort of Business?

Your options

One thing you will have to do from the outset is decide what sort of business you want to set up. You have three choices:

• To be a sole trader
• To form a partnership
• To form a limited company.

Sole trader

A sole trader is the simplest business entity and basically means that the person and the business are one and the same. Most self-employed tradesmen fall into this category. The big advantage is that it is easy to set up and run a business as a sole trader – all you will need to do is register with your tax office and keep a fairly straightforward set of accounts.

You are liable for your own costs, tax and National Insurance, but beyond that you keep what you earn.

The disadvantages are that you cannot be a sole trader if you want to include other people in your business and the arrangement might not be very tax-efficient if you make a fair amount of profit. If you do not trade under your own name, you will need to show your name and address on your stationery and at your work place.

Partnership

A partnership is when the business represents two or more persons who, technically, have joint responsibility and liability for what the business does. This is the type of arrangement most often used by purveyors of professional services, such as lawyers or accountants. There can be tax advantages in setting up this kind of business with your spouse (or someone else you have a relationship with), but your accounts will be more complex – you will have to complete a tax return for each partner and a separate one for the partnership, for instance. Other points to note are:

• There is no limit to the level of involvement a partner can have in the business; they can work on it full-time or not at all.
• Similarly, there is no restriction on them working elsewhere, so they could even have a full-time job of their own. (Although in this case their earnings might have an effect on how tax-efficient it is for them to be involved – see Chapter 5.)
• Although it is not a legal requirement, you might want to get a solicitor to draw up a partnership agreement if you think there could at some point be any dispute or disagreement over ownership, share of profits or other areas of the business.
• Each partner has ‘joint and several liability’ for the finances of the business. This effectively means you can be responsible for any debts your partner might run up.
• Since 2001, however, legislation in the UK has allowed for the formation of limited liability partnerships (often abbreviated to LLPs). As their name indicates, these are partnerships where the partners do not have unlimited liability for each other’s actions, conferring a level of protection similar to that afforded to the directors of a limited company.

Limited company

A limited company is where the business is a separate legal entity from the people who own it, manage it and work in it. Most businesses with medium or large turnovers fall into this category and there is a number of reasons why. For example, a limited company is taxed at a much lower rate (around ten per cent) than an individual and profits can be taken out tax-free in the form of a dividend, increasing the amount of cash you can keep if you are a higher-rate taxpayer. Also, if the business runs into trouble, the liability for losses is limited to the company (hence the name ‘limited company’) and although directors do have a measure of personal responsibility for the affairs of the business, they are not exposed to the level of risk that they would be as sole traders or partners. However, there is a downside. Establishing a limited company involves more administration. Accounts and annual returns have to be filed at Companies House every year within specified dates, for example, and it is essential to appoint a company secretary and follow established procedures in the running of the business. As a director, you will be an employee of the company and will be subject to benefit-in-kind rules which will mean you will incur additional tax and National Insurance for things like company cars.

Which is best?

There are no hard and fast rules as to which type of business you should set up. You will need to consider which best suits the kind of operation you have in mind. For example:

• If you do not anticipate earning enough to put you in the higher-rate tax bracket (around £ 34,600 a year) and shudder at the thought of a lot of paperwork, you would probably be better off working as a sole trader.
• If your earnings are likely to exceed £ 34,000 and you have a spouse or partner who is earning less, forming a partnership can allow you to split the profits from your business so you do not end up paying higher rate tax.
• A limited company can appear more professional and, potentially, is a good option if you are planning to go into business with others. But it involves a degree more hassle and is unlikely to be worth the effort unless you plan to earn substantial amounts of money.

Of course, there is nothing to stop you starting out with one type of business and altering it as your circumstances change. However, bear in mind that moving up the scale from sole trader to partnership to limited company is a lot more straightforward than doing the reverse.