How to choose the right business structure

Choosing the correct business structure is a crucial step when starting a business. It affects everything from how you’re taxed and the level of personal liability you face to how much control you retain and the way you manage your business.

This guide covers the key factors to consider when selecting a business structure, so you can make the right decision.

Key takeaways

• The four main business structures are sole trader, partnership, limited company and limited liability partnership

• It’s important to consider legal liability and your risk tolerance before deciding on a business structure

• Factors such as tax obligations, your growth plans and funding requirements should also influence your choice

• You need to review your business structure as your enterprise grows

What are the different business structures?

Before we go any further, below is a quick overview of the main business structures you can choose from:

• Sole trader –You run this type of business by yourself, meaning you are responsible for all decisions, although you may hire employees

• Partnership –Here, you run your business with at least one other person and agree to share profits and losses

• Limited company –This is a more formal structure. The business is a separate legal entity, so its finances are separate from your own

• Limited liability partnership (LLP) –This is similar to a partnership, but each partner’s liability is limited to the amount of cash they invest in the business

Factors to consider when choosing a business structure

To help you choose the best business structure, it’s important to consider the following factors:

1. Legal liability

Legal liability is a key consideration because it defines how personally responsible you are for the business’s debts and legal commitments.

As a sole trader, you are personally responsible for any legal issues your company has, as well as your company’s debts. That’s because you and your business are one and the same – there’s no legal distinction.

This also applies to general partnerships – you and your partners have personal liability for the debts of the business.

By contrast, limited companies and limited liability partnerships offer limited liability. This means you, as the owner, are not generally liable for business debts.

2. Risk tolerance

This ties into the above. When choosing your business structure, consider how much risk you’re willing to accept and the type of risks your company might encounter.

If you’re starting a business on your own and believe the risks are low, you might be comfortable setting up as a sole trader. However, if you’re concerned about being personally liable for any business debts, you may prefer the greater legal protection provided by a limited company or an LLP.

3. Tax considerations

Different business structures have different tax obligations, and it’s important to understand these before you choose your business type.

As a sole trader or business partnership, you must submit your own tax return and pay income tax on your profits. This calculation uses your personal income tax rate, so higher earners can pay a higher rate of tax.

Limited companies, on the other hand, pay corporation tax on their business profits. Companies with augmented profits under £50,000 pay the small profits rate of 19%, while those with profits above £250,000 pay the main rate of 25%. Businesses with profits between these thresholds may benefit from marginal relief – that is, a rate somewhere between the two, depending on your profits.[KL1]

As the owner of a limited company, you can also draw a salary and receive dividends, offering greater flexibility in how you pay yourself, potentially reducing your overall tax burden.

Read more:

• Sole trader vs limited company

• How to register a business

4. Control and management

Another key consideration is how much control you want over the business. As a sole trader, you retain complete control and can make all decisions independently – this can be ideal for small, personal ventures, such as a window cleaning business.

If you’d rather share responsibilities and collaborate with others, a partnership might be a better fit. But it’s important to trust your partners and agree on who does what.

If you’re aiming for fast growth and want to delegate some control – by bringing in directors or investors, for example – setting up as a limited company could be the most suitable option.

5. Administration

Setting up as a sole trader or general partnership is generally straightforward, with minimal paperwork and fewer compliance obligations.

By contrast, limited companies and LLPs involve more complex administration, including filing annual accounts and maintaining proper records. However, they also offer greater legal protection. If you’re comfortable managing the extra admin yourself or you plan to hire an accountant to help, you might be happy with these structures.

6. Future plans

You should also think about where you want to be in the next five to ten years. How big do you want to grow the business? Are you likely to take on more staff or maybe even sell the business at some point?

Although it’s relatively easy to set up as a sole trader, it’s more difficult to expand. If you plan to stay small, this might be sufficient, but if you want to grow and get investors, a limited company is likely to be more suitable.

7. Funding requirements

Many businesses require funding at some point, so it’s important to consider this because there are several options to explore.

If you’re a sole trader, you might be able to borrow through a loan or from friends and family.

However, if you’re looking to secure a larger sum or want to attract investors, a limited company could be a more suitable structure. Banks are generally more willing to lend to limited companies, and this setup also makes it easier to approach venture capitalists or other professional investors.

Review your business structure

If you’re not sure which business structure is right for you or have specific questions or concerns, it’s a good idea to seek professional financial and legal advice before deciding.

But even once you’ve made your choice, your business structure isn’t fixed for ever, and it’s important to review it as your business grows. For example, you might start off as a sole trader but transition to a limited company a few years down the track. Again, it can be worth seeking professional advice before you switch to ensure you are aware of all the steps you need to take and how your legal and tax obligations could change.