Having decided to set up in business on your own, it is vital that you choose the best legal structure for your circumstances. This choice will have a significant impact on the way in which your business can operate in the future, and will determine things like the records you have to keep and the ways in which you can raise money for your business. It is important that you get it right from the start.

There are three main legal structures that may be considered by those who are becoming self employed.

Sole trader

A sole trader arrangement is the simplest way for an individual to get set up in business. There is no need to register as a business, although you will need to register as self employed with HM Revenue and Customs.

You will make all of the decisions regarding the running of your business. You do not have to answer to other shareholders. All of the profits generated by the business go straight to you.

All of those profits are treated as regular income for tax purposes. As such, you need only fill in an annual self assessment tax return; you do not need to worry about corporation tax. You are expected to keep records of business income and expenditure.

The most significant downside of the sole trader arrangement is that you will be personally liable for any debts run up as a result of your business activities. In the worst cases this means that you risk losing your home and other assets in the event that the business does not perform as intended.

Click here for more information on setting up as a sole trader.

Partnership

There are two kinds of partnership; a ‘conventional’ partnership and a limited liability partnership.

A conventional partnership is similar to a sole trader arrangement, except the risks and benefits are shared amongst two or more individuals. Again, it is not necessary to register this arrangement with Companies House, but each of the partners must register as self employed.

The partnership must complete an annual self assessment, as must each individual partner. The partnership is also expected to keep business accounts.

Liability for any debts run up by the business is shared amongst the partners, as are the profits. The manner in which these are shared should be decided upon in advance, and outlined in the deed of partnership – a document explaining how the partnership will be run.

In England, Wales and Northern Ireland, the partners are jointly liable for debts run up by the partnership. This means that each partner has an equal responsibility for the debt. In Scotland the partners are jointly and severally liable. This means that each partner has an equal responsibility, but that each partner could also be held personally liable for the entire debt.

Click here for more information on setting up a partnership.

In order to minimise this liability many people choose to set up a limited liability partnership (LLP).

A limited liability partnership is similar to a conventional partnership. However, it is treated as a legal entity in its own right, separate from the partners. However, each partner is only liable for a loss of the same value as the amount they have invested. Individual partners cannot be held liable for debts run up by the business above this amount.

Click here for more information on registering a limited liability partnership.

Limited company

Limited companies, like LLPs, have a legal existence separate to that of their owners. Limited companies have shareholders, and these individuals’ liability is limited to the amount that they invest. There may be one or more shareholders. Public limited companies (PLCs) can offer shares for sale to the public in order to raise finance.

Limited companies must be incorporated at Companies House, and must satisfy a number of legal demands. Company directors are personally responsible for ensuring that an annual return is made to Companies House, and that tax is paid on time.

If a limited company makes a profit, this may be distributed to shareholders through a dividend. Employees may also draw a salary. However, profits are subject to corporation tax.

Click here for more information on registering a limited company.

Although it is possible to change the legal structure of your business at a later date, this can be a long and expensive process. You should give serious thought to the type of legal structure that would suit your business best. Seek advice from a solicitor or accountant before coming to a decision.