Choosing a Business Structure

When starting your own business, one of the first things you need to do is decide what legal structure your business is going to have.

If you are setting up in business on your own you have two choices – you can either work as a self-employed sole-trader, or you can form your own limited company of which you would be a director.

If you are going into business with other people, then you can still opt to form a limited company, or you could become partners in either a partnership or a limited liability partnership.

This article looks at the pros and cons of each option.


Becoming a self-employed sole-trader is probably the most straightforward way of going into business on your own.

As a sole-trader, there is no legal distinction between you and your business.

On the plus side, this means the procedures for registering your business are a lot simpler than for a limited company. All you need to do is notify the Inland Revenue that you have begun trading as a self-employed individual. You can do this by calling the Inland Revenue’s helpline for the newly self-employed (0845 915 4515) or filling in form CWF1 on the Revenue’s website.

NB – you must tell the Inland Revenue you have become self-employed within three months of the end of the month when your self-employment begins. Failure to do so may result in a £100 fine.

The down side of having no legal separation between you and your business is that you are personally liable for the actions and any debts of your business. If the nature of your business means it requires significant investment or borrowing, this can make the sole-trader route a riskier one than some of the other options such as a limited company.

The record-keeping requirements for a sole-trader business are relatively simple. You will need to prepare basic accounts for the business each year showing the income and expenses of the business. You can do this yourself, or you can use the services of an accountant. You will also have to submit a self-assessment return each year which will include details of your business’s profits or losses.

As you and your business are essentially one and the same, all your profits from trading go straight to you and these profits are taxed as your own income. You will have to pay income tax on this money. In addition you will have to pay a fixed Class 2 National Insurance contribution each week, together with Class 4 NICs on whatever profits you make.


If two or more people want to go into business together, they can form a partnership.

Just like with a sole-trader business, this is a fairly informal arrangement and the partnership is not a distinct legal entity. So, in the same way as for a sole-trader, the partners are personally responsible for any debts the business runs up.

Moreover, each partner is jointly and severally liable for the partnerships debts. This means if one partner runs up large debts on behalf of the partnership and then disappears, the remaining partner(s) can be pursued by the partnership’s creditors. It is therefore very important to ensure you can trust the other members of the partnership.

The profits of the partnership are shared amongst the partners and count as part of their own income. Each partner pays income tax and National Insurance on his share of the profits in the same was as a sole-trader does.

The record-keeping and accounting requirements of a partnership are the same as those described above for a self-employed sole-trader business.

Limited Liability Partnerships (LLP)

Limited liability partnerships were introduced in this country a few years ago as a way in which people could form a partnership that was viewed as a separate legal entity in its own right.

Just like limited companies, LLPs are registered with Companies House. They also have to have a Registered Office.

The advantage of an LLP over a traditional partnership is that each partner’s liability is limited to the amount of money they have invested in the business and to any personal guarantees they have given to raise finance.

Like a normal partnership, an LLP can have any number of partners (subject to a minimum of two). However, at least two of the partners have to be “designated members”. The designated members have extra legal responsibilities such as ensuring that accounts are delivered to Companies House on time.

The accounting and taxation of LLPs works in the same way as traditional partnerships.

Limited Liability Companies (Ltd Companies)

Limited companies are separate legal entities. They exist in their own right and are owned by their shareholders.

Shareholders are not responsible for the debts of the company. Therefore, setting up your business as a limited company affords you more protection if the business fails.

A limited company is run by a board of directors. The directors have a duty to act in the best interests of the company and its shareholders.

The company must have at least one director, as well as a company secretary (i.e. a minimum of two company officers). If required, the person who is company secretary can be a director of the company inb addition to being the company secreatary. The directors and company secretary can also be shareholders in the company.

If you decide to run your new business as a limited company, it is unlikely that you will be self-employed. Instead you will be a director and an employee of your new limited company. It is then up to you (and the other directors if there are any) to decide what level of salary the company will pay you. You will pay PAYE tax on this salary just like all other employees.

In most cases, you will probably want to be a shareholder of the company as well, so as you can share in its profits.

Every limited company has to have a Registered Office. This is an address where official documents and notices may be served.

To form a limited company, there are various forms which have to be submitted to Companies House. Click here for an article which gives more detail on the steps involved in forming a limited company.

A limited company has to keep proper accounts showing its income, expenditure, and profits/losses. These accounts have to be filed with Companies House each year.

Because it is a separate legal entity, the profits of a limited company are taxed separately from the income of its directors and shareholders. The profits are taxed according to the rules on Corporation Tax and the company pays the appropriate amount of Corporation Tax out of its pre-tax profits.

Some or all of any profits the company makes can then be distributed to its shareholders in the form of dividends.

This type of structure offers greater flexibility in terms of tax planning and can lead to your overall tax bill being lower than it would be if you ran your business as a sole-trader or through a partnership.

For example, you might decide to take a fairly low salary from your limited company (e.g. £6000 per annum) and take the rest of your income as dividends. The advantage of this is that there is no National Insurance paid on dividends, whereas there is on your salary.

Also, if your business does very well in a particular year and you do not need to pay out all the profits to yourself as dividends in order to live, then you can leave these surplus profits in the company to cover leaner years or to build up a retirement fund. In this way, you can avoid paying 40% income tax on every single penny of profit your business makes each year. This option is not available to sole-traders and partnerships.

Before deciding on the best structure for your new business, we recommend you take professional advice from an accountant who specialises in advising start-up businesses. They can explain the various accounting and taxation advantages and disadvantages of each structure and help you come to a decision as to the best way to operate your new business.

Click here to sign up for our business advice newsletter.

Copyright © 2004-2007 Divadani Limited. Terms and conditions of use.