This is the first part of Helen Paull’s article on business struture and it covers Sole Traders and Partnerships. The second part of the article can be found here: Business Structure Part 2.
About the author: Helen Paull is a newly qualified solicitor at Lindleys specialising in company/commercial and commercial property matters.
Setting up a business
Setting up a business can be stressful. You may know everything about your business, but whether to trade as a sole trader, a company or a partnership, taking on premises or becoming an employer it can seem daunting. Hopefully these articles will make it less so!
First of all we’ll tackle business formation and structure.
So what will your business structure be?
The simplest form of business structure, suitable whether you will be working alone or employing people. The key element is that you are the only owner of the business. Accounts are only needed for calculating your personal tax and for VAT or your own record keeping. They are not publically available. You must register with HMRC as self employed and submit annual self assessment tax returns.
The main disadvantage is that you are the business and therefore liable for all its debts. If the business incurs debts which it cannot pay, the creditors can claim from you personally. This can also include liability under contracts or leases that you enter into as part of the business. Sole traders can often find it difficult to obtain funding from banks and may need to use other resources e.g. family or savings to get their business up and running. Any profit is treated as your personal income and taxed at the usual basic and higher rates. In effect you pay tax on the ‘paper profit’ whether or not you can physically withdraw it from the business. It is often the chosen vehicle for smaller or start-up businesses.
A partnership is similar to a sole trader in many ways but all the partners are liable for debts. This arrangement is useful when two or more people want to go into business together but do not want the formality of running a company. Whether a partnership exists is a question of fact, it does not require any formal paperwork to create it and so you may already be in one and not know it! The test is two or more people trading together with a view to making a profit.
As with a sole trader, all the profits are treated as income and each individual pays income tax on his share of the profits. In a partnership these profits can either be divided equally between the partners or in any other way. Although no paperwork is required to form a partnership, it is advisable to have a written partnership agreement to regulate the relationship e.g. to agree the division of profits and losses and the process for people leaving or joining the partnership. If there is no written agreement the partnership is governed by the Partnership Act 1890, is terminable at will by any partner and has no implied restrictions on an ex partner.
As a partnership is not a separate legal entity, property is usually held by one or more of the partners on trust for all of them. Should the partnership fail any creditors can pursue the individual partners. Each one is ‘jointly and severally liable’ i.e. a creditor can choose who to pursue and can seek to recover 100% of the debt from any partner.