There comes a time when a good idea starts to look like something that’ll make a significant amount of money. When this happens, you won’t just attract customers as HMRC will also take an interest. So, what do you do? Here's how to choose the right structure for your business
It must be one of the best of dreams, to earn your living doing what’s essentially your hobby. If you’re a budding architect, caterer, artist or plumber, owning your business is a thrill. But you need to get it right from the start.
You may need funding, if so there are plenty of options. But either way you’ll need to figure out what type of business you want to run.
If you earn more than £1,000 a year and work for yourself, you’re likely to be classified as self-employed, and will need to declare your status to HMRC.
You can be self-employed and employed at the same time, fir example if you run your own business in the evenings after a day at work.
Of course, anyone starting up their own business has a lot to think about, from how big they see their business in a year or two’s time to whether they’ll be an employer themselves soon.
These factors, and others, will determine whether you set up as a sole trader or a limited company.
A sole trader is a self-employed person who’s treated as the same single entity as their business. This means as a business owner you’d be responsible for any debts incurred by the business, which means you could lose your personal savings or even your home if things went drastically wrong.
On the plus side, being a sole trader business is simpler to set up and run, being far less formal than setting up a limited company. You simply need to file a self-assessment tax return each year and keep a record of income and outgoings.
On the negative side, you’ll pay more tax, and you might find some potential clients won’t work with you as they prefer to deal with limited companies.
If you set up as a limited company, you and your business are treated as separate entities. This means you, your shareholders and directors can’t be pursued for debts incurred through your work.
Starting a limited company is costlier and more time consuming than become as sole trader. You’ll need to fill in a lot more paperwork, and register with Companies House. This means submitting financial reports that’ll be in the public domain, so anyone can read them.
On the plus side, this greater level of transparency can encourage potential lenders and investors to consider you as a viable option.
If you’ve got a great idea for a business and are keen to get up and running as soon as possible becoming a sole trader could fit the bill.
This type of self-employed status may suit you if you’re planning to work on your own, rather than employ staff.
To be a sole trader you must meet the following requirements and take the following steps:
Prove you earned more than £1,000 in the last full tax year (to 5 April)
Prove you’re self-employed. Having invoices to hand for work you’ve done will help. This is important as you may be entitled to welfare benefits to top up your income
If you’re wondering whether sole traders pay corporation tax, the answer is no.
You’ll pay income tax at the basic rate of 20%, the higher rate of 40%, or additional rate of 45% depending on your annual income.
As such, inform HMRC and register for self-assessment so you can file a tax return every year. It’s worth noting that there’s a slightly different route to registering with HMRC if you work in the construction industry or you’re a professional fisherman.
Also, if your business really takes off and you find you’re earning more than £85,000 you must register for VAT.
As a sole trader you can name your business – although it’s not a legal requirement. Naming your business is useful if you’ll be invoicing other companies or individuals and you plan to advertise your services or wares.
What you call your business is, well, your business. Many small operations simply use their own name. But there’s a few things to bear in mind. You can’t:
Include any of the following in your business name – limited, Ltd, limited liability partnership, LLP, public limited company, plc.
Use offensive language or terms
Use and existing trade mark
Claim you are accredited by another company or organisation unless this is true
You’ll find there’s a lot more involved in setting up a limited company than there is with becoming a sole trader. This is largely because there are two types of limited company:
Limited by shares – meaning the company is expected to make a profit, which are paid to shareholders
Limited by guarantee – meaning you’re running a company that’s typically not for profit. Where profits are made these are invested back into the company.
In both cases the firm is legally separate from the person or people who own and run it. If this sounds like the type of company you’ll be heading up, here’s how to proceed:
You’re legally obliged to choose a suitable company name, which will need to be registered with Companies House. Your company name mustn’t it be so similar to an existing firm that there could be confusion.
Helpfully, there’s a search tool on the Companies House website so you can check whether the name you want is available. When checking make sure the name you register isn’t offensive. It must usually include the affix ‘limited’, ‘Ltd’, or the Welsh equivalents.
You’ll need to appoint a director if you’re setting up a limited company. This person will be responsible for keeping company records up-to-date, file accounts and the company tax return.
They’ll also have to tell any shareholders if they’ll potentially benefit from a business transaction and must follow the company’s rules, as shown in its articles of association. This document details how the company will be run, and must be agreed by all shareholders or guarantors, directors and the company secretary.
Being a director isn’t a job to take lightly. If you fail in your responsibilities, you could be fined, prosecuted or disqualified from being a company director. This is the case even if you appoint others, such as an accountant to manage certain essential tasks. In short, the buck stops with the director.
If you plan to make a profit, you’ll need to issue shares. Initially this can be the director alone, who holds all of the shares. Alternatively, you could sell shares to others, and it’s up to you to settle on a price per share. You’ll need to report the number of shares issued and their total value in a ‘statement of capital’.
You’ll need to state the name and address of each shareholder. Also, you’ll be required to identify any shareholders who’d be classed as people with significant control over the business. These would typically be people who own a large portion of shares.
Aside from details of personnel such as the director, company secretary and shareholders, you’ll need to ensure other information is recorded and kept current. This includes:
The results of shareholder votes
Promises to repay business loans by a certain date in the future, known as debentures, with the details of all lenders
Loans and mortgages that are secured against the firm’s assets
Promises to make payments should something go wrong that is deemed to be the company’s fault. These are known as indemnities.
Comprehensive accounting records – which must be kept for at least six years from the end of the relevant financial year
Once you’ve got everything in place, you can register your business with Companies House. It’s a good idea to register for corporation tax at around the same time. As the owner of a limited company you won’t pay income tax, rather you’ll pay corporation tax at a rate of 19%.
The nature and scale of your business might make the choice between being a sole trader or a limited company relatively straight forward. But, if you’re still not sure consider the following pluses and minuses of both (and take advice from a specialist accountant if you’re still unsure):
|Sole trader||Limited company|
|Set up||Quick and easy||Takes time to ensure legal requirements are met|
|Ownership||You’re the boss||You’re answerable to shareholders and partners|
|Profits||You keep all the profits||Profits distributed among shareholders|
|Tax||You’ll pay income tax of between 20% and 45%||You’ll pay corporation tax at 19% on profits|
|Privacy||You have greater privacy||Some company details in the public domain|