Four business structure types and how to choose the best one for you

If you’re starting your own business, it’s essential to understand the different types of business structure so that you can choose the one that best aligns with your business intentions. 

The type of structure you pick can affect small business tax, financial liability and how your business can raise funds, so it's crucial to choose a structure that aligns with your business goals and long-term plans. Here’s what you need to know.

Key takeaways

• There are four main types of business structures: sole trader, partnership, limited liability partnership and limited company.

• When comparing business structures, consider the tax implications, financial liability, your funding requirements and your future growth plans.

• If you’re unsure which business structure is right for you, it’s best to seek financial and legal advice first.

What are the different types of business structures? 

In the UK, there are four main types of business structure. When comparing them, you need to consider the pros and cons of each to determine which best suits your business plans.  

1. Sole trader

If you’re just starting out, one of the most popular and straightforward options is to set up as a sole trader. You run this type of business by yourself and you will be responsible for all business decisions, although you can still have employees.

As a sole trader, there’s no legal distinction between you and your business. This means you can decide to keep all business profits once you’ve paid income tax and National Insurance. But it also means you are personally responsible for all debts and must maintain accurate financial records, complete your self-assessment tax return, and pay your taxes on time. You may wish to consult an accountant to help you.  

Be aware that if your sole trading income exceeds £90,000, you must register for VAT and submit a VAT return too.

Many hairdressers, freelancers and photographers are sole traders. 

2. Partnership

In a partnership, you run your business with at least one other person. You and your business partner(s) must register with HMRC separately, but as part of the same partnership. This means you must each submit a separate tax return. Your tax and National Insurance obligations will be similar to those of a sole trader. 

You must also sign a partnership agreement to decide how to run the business and how to split profits and liabilities, including who has responsibility for managing the accounts. 

There is no legal limit to the number of partners you can have, but it can be more difficult if there are several of you. Setting up a partnership can lower the stress of running a business, but it can also be harder to make business decisions and ensure everyone is putting in the same amount of effort for a fair share of the profits.

Examples of partnerships include law firms, dentists and accountancy practices.

3. Limited company

If you set up as a limited company, you must register your business with Companies House. As a limited company, your business is a separate legal entity which means its finances are separate from your own.

This can make it less risky for you, as the company has limited liability. In other words, if the company can’t repay its debts or someone takes legal action against the business, you are only liable for the face value of your share in the business. Beyond that, your personal assets have protection.

A limited company is a more formal business structure and can offer some protection for its shareholders (anyone who holds shares in the company) and directors. All shareholders must sign a memorandum and articles of association that set out how to run the business and rules for how it operates. 

Limited companies must also register for corporation tax and submit an annual company tax return and full statutory accounts to HMRC and Companies House. Information given to Companies House is public, so anyone can view it. 

Additionally, limited companies must pay employees’ income tax and National Insurance contributions. 

Some common examples of limited companies include retailers, restaurants and building contractors, but you could also set up as a limited company if you’re a driving instructor, a plumber or an electrician, for example.  

4. Limited liability partnership

A limited liability partnership (LLP) is similar to a partnership, but each partner’s liability is limited to the amount of money they invest in the business. 

You must register an LLP with Companies House and HMRC, but all members must submit a personal self-assessment tax return, pay income tax on their share of the profits and pay National Insurance. You must also prepare and submit annual accounts, so you may want to hire an accountant, and you may need a company secretary.

Common examples of LLPs include legal firms and accountants. 

Read more:

• Sole trader vs limited company

• Types of business ownership

What type of business structure should I choose? 

When weighing up the different business structure types, you need to think about the following factors:

Financial risk and liability

Firstly, it’s important to consider how much risk you’re prepared to personally take, as well as the risks your company might encounter. This means assessing whether you’re happier keeping your personal and business finances separate and how likely it is that your business will face legal challenges. 

If you feel there is relatively little risk with your business, you might feel comfortable setting up as a sole trader or partnership. But, if the idea of personal liability concerns you, you might be better off setting up as a limited company or LLP.

Tax implications

It’s important to have a clear understanding of how much tax you must pay for each business structure, including when you need to pay tax and what accounts you need to file.

As a sole trader or partnership, you need to submit your own tax return and pay income tax on your profits. This calculation uses your personal income tax rate, so higher earners can end up paying high rates of tax.

As a limited company, you pay corporation tax on your business profits, with the small profits rate (19%) applying to companies with augmented profits under £50,000, the main rate (25%) applying to those with augmented profits over £250,000, and marginal relief available for companies with augmented profits between £50,000 and £250,000.

As a limited company owner, you can also pay yourself a salary and receive dividends, which gives you more flexibility and can lower your overall tax liability. 

Control

Also think about how much control you want in your business - or how much you’re happy to give to others. If you’re setting up a small photography business, for instance, you might know the direction you want to take and prefer to retain full control, in which case, you could set up as a sole trader. 

Alternatively, if you’d prefer someone else to bounce ideas off who can support you in the day-to-day running of the business, a partnership could be a better choice. Or, if you plan to expand fast and hand over some control to others, a limited company might be more suitable.

Business administration

Another point to think about is how much business admin you can take on. It’s relatively easy to set up as a sole trader or partnership, with minimal paperwork and compliance requirements. 

Limited companies and LLPs have more complex administrative tasks, and you need to file annual company accounts, but you can also benefit from additional legal protection. If you’re likely to hire professionals to help with the admin — or you’re happy to tackle the accounts yourself — these structures might work for your business. 

Funding requirements

If you plan to seek outside funding for your business at some point, setting up as a limited company or partnership could increase your chances of securing it. For example, you could pitch your business to venture capitalists, and banks often favour lending to limited companies.

If you plan to rely on your savings or seek support from friends and family, setting up as a sole trader may be a more suitable option.

Future plans

Finally, think about your overall plans for the business and where you want to be in the next five to 10 years. Consider how big you want your business to be, whether you’re likely to hire more staff, and whether you might sell the business at some point.

Setting up as a sole trader can be relatively easy, but it’s not so easy to expand. However, if you’re happy running a small business by yourself, this might be sufficient. 

On the other hand, if you have big plans to expand, get investors, and one day go public, you should consider setting up as a limited company.

If you have any questions or concerns and are unsure which structure is best for your business, you should seek financial and legal advice first. 

Other business structures

Although they are not as common, other legal structures worth mentioning include:

• Franchise: A franchise is an arrangement where an established company sells the rights to use its name, trademarks and business model to independent operators, known as franchisees. The franchisee pays a fee, along with ongoing royalties or a percentage of their sales revenue, to the franchise company. On the plus side, workload and startup costs can be lower.

• Charity: A charity is an organisation established for charitable purposes that receives income through grants and donations rather than trade. Charities can pay reduced business rates and receive tax breaks.

• Community interest company: This structure is like a normal limited company, but it’s designed for social enterprises or not-for-profit organisations. It exists to benefit the community rather than private shareholders. 

• Co-operative: A co-operative is a business or organisation democratically owned and controlled by its members, who can be customers, suppliers, or employees. They can have a say in the company's operations and work together to meet a shared need. 

• Offshore company: This is a type of business that’s registered in another country. This type of business structure can enable you to take advantage of more favourable tax laws.