One of the major decisions you need to take once you decide upon starting a company is its legal structure. I touched on my decision in the first blog post, but I thought it would be worth going over the different options in greater detail, and why I decided to make the decision I did.
First and foremost, there are four main types of companies (although these can be split further down, these are the overarching entities): sole trader, partnership, private limited company and public limited company.
The company’s legal structure defines how it fundamentally operates, in terms of who owns the profits (or losses), tax system, how funds can be raised and other legal bits and bobs.
- Sole Trader: As the name suggests, you start the business on your own. You file your taxes under the self-assessment tax system, and you are responsible for all the debts (called unincorporated), but you also take all the profits.
- Partnership: Again, the name gives this one away; two or more people form the company. There are a few types of partnerships, but without wanting to get into the nitty gritty, these are governed by a ‘partnership agreement’, which defines profit sharing, what happens if a new partner joins or an old one leaves, and other details linking the partnership together. Again this is unincorporated, so the people who founded the business are responsible for any losses incurred.
- Private Limited Company: Unlike the previous two options, this creates an incorporated business. This essentially means that the company has become a separate legal person. All profits and losses are ‘owned’ by the company, and there is better continuity if one of the Directors leaves for whatever reason. This system also makes it easier to attract funds from outside investors, and generally gives better options for expansion in the future, whilst keeping full control.
- Public Limited Company: The shares for these companies are available for public sales (unlike all previous options). This obviously makes it a lot easier to attract investors; however, you need a substantial amount of capital in order to start this type of business up, and with every share you sell, you lose some control. This is an incorporated company, so again, losses are limited.
Although the above may sound complicated, you can quickly identify the type of company you want to start by asking yourself a few simple questions: how much funding do you have, how much control do you want to keep, what are your plans for expansion, how easy do you want to make it to set up and file tax returns and most importantly do you want to be responsible for losses.
The final comment refers to whether the company is incorporated or not. Essentially if it’s incorporated, your liability is limited to the amount unpaid on shares you hold, so you’re a lot more secure. If it’s unincorporated, in theory, if it all goes wrong, you could lose everything.
I went for a private limited company, rather than a partnership. This was mainly due to the fact that private limited companies tend to have a greater status, so would be better for us when dealing with other companies. Although our business is currently small scale, creating this ‘legal person’ was also quite an advantage, whilst also keeping control of the company and allowing for scope to grow if that happens.
This can all boggle the mind, and despite trying to simplify this as much as possible, I’m conscious that there is still a lot of business jargon. But before creating a company, asking yourself some of the questions above are essential in identifying the right legal entity for you, and then the rest will follow.