Legal structures might not sound like the most riveting of subjects, but it’s actually pretty exciting. The legal structure you choose is essentially the very foundations on which you can build your company. It’s the way it’ll work within the system, so it’s important that you get this bit right.

Sound a little daunting? You don’t have to worry. Below we’re going to go through some digestable summaries of the main legal structures used in startups in the UK.

Sole trader

A sole trader runs their business as an individual. Contrary to popular belief, a sole trader can employ staff. The reason it is referred to as ‘sole’ is that you and your business are the same thing. You do not have to register at Companies House for this legal structure, but you must complete all the required paperwork for HMRC.

Advantages

  • Profit: After you’ve paid tax, all profits are yours

Disadvantages

  • Tax: You have to pay income tax on any profits you make as opposed to corporation tax
  • Liability: You are held personally responsible for any and all business loans and debts. This mean that you can be forced to sell your personal assets to pay off debts

Limited company /company limited by shares

If you’re running a limited company, the liability of the shareholders is ‘limited’ to the value of their shares they have in the company. This legal structure is one of the most commonly used.

To form a limited company, you must have at least one director and one shareholder. The director and shareholder can be the same person. You must also choose between the suffix Limited or Ltd (for more on company names, read Choosing a Company Name).

Advantages

  • Tax: The company is under corporation tax
  • Limited liability: The company is liable for any losses, not you. Shareholders are capped at the value of their shares
  • Trust: Trading as a limited company inspires trust in users
  • Company name: Limited company names must be unique so your trading name is protected

Disadvantages

  • Transparency: There is a certain level of transparency needed in a limited company which is disclosed to Companies House and much of it is displayed on the public records. This includes information on directors, shareholders, PSCs and any other officers. You must also provide an Annual Confirmation Statement and Annual Accounts to Companies House.
  • Admin and accountancy: There is an administrative burden due to certain procedures including retaining Statutory Registers. Also, accountancy fees are, generally, slightly more expensive as limited companies can have quite complicated accounts.

Company limited by guarantee

A company limited by guarantee is normally a structure chosen for social enterprises, charities and sports clubs. It has no share capital, but still has limited liability. As opposed to having members, you have ‘guarantors’ whose liability is limited to an amount specified in the Articles of Association. This nominal amount guarantees that the guarantors will contribute to any debts.

To form a company limited by guarantee, you must have at least one director and one guarantor (they can be the same person). The company does not need the suffix Limited if you include a not-for-profit distribution clause in the Articles of Association if the object of the company is to follow any of the items mentioned in this list.

Advantages

  • Limited liability: Same benefits of a limited company apply to a company limited by guarantee
  • Suffix: A company limited by guarantee does need the suffix Limited orLtd if it follows these rules. This will boost it’s not-for-profit reputation

Disadvantages

  • Profits: You can’t extract profits as they are usually used to further the objects of the company
  • Transparency, admin and accountancy: A company limited by guarantee has the same disadvantages as a limited company

Limited Liability Partnership (LLP)

LLPs lend themselves well to firms of accountants, solicitors and architects. They offer the benefits of working in a partnership whilst having the protection of limited liability.

LLPs need at least two designated members and must choose between the suffixes LLP or Limited Liability Partnership.

LLP profits are under income tax as opposed to corporation tax. However, this can be an advantage or a disadvantage dependent on earnings.

Advantages

  • Limited liability: Same benefits of a limited company apply to an LLP
  • Flexibility: LLPs provide the flexibility of a partnership

Disadvantages

  • Transparency, admin and accountancy: A company limited by guarantee has the same disadvantages as a limited company
  • Organisation: The two designated members bear the responsibility for meeting the statutory requirements of the LLP

Community Interest Companies (CIC)

CICs are a type of limited company that are tailored for social enterprises that want to use their profits and assets for social good. It includes features such as the asset lock to ensure that profits can only be used to further their objectives.

CICs must be limited companies and not charities or political groups. When applying for a CIC, you must include a ‘community interest statement’.

Advantages

  • Admin: There is less admin, regulations and restrictions on trading activities than a charity
  • Earnings: Directors can be paid a salary and shareholders can get dividends, although they are capped at an upper limit

Disadvantages

  • Regulations: CICs have more restrictions than a normal limited company including working within a community specified in your community interest statement. You must also submit annual community interest reports
  • Shareholders: Shareholders have limited benefits due to upper limits on their dividends. Moreover, the asset lock requires that assets are transferred at full market value to another asset-locked organisation
  • Funding: There is less funding for CICs than other company types

Other

There are other types and structures of companies including unlimited companies and Public Limited Companies (PLCs). However, PLCs are costly structures and we suggest you have a good chat with a professional advisor or your accountant before forming one.