Choosing the structure of your business and identifying the accompanying legal requirements is absolutely essential; as this will affect how you run your business, how you do business in the future and, perhaps most importantly, the tax you pay.
It doesn’t matter what home-based business you are planning; it could be a nail salon, pet grooming service, language tutor, physiotherapist, landscape gardener, affiliate marketer, or eBay seller. Before you take another step, you need to decide what kind of legal structure will be most suitable for your venture.
The 3 Most Common Types of Business Structures
While there are a number of different types of business structure, there only three main types that you need to explore when operating a home-based business: Sole proprietorship, Partnership or Private Limited Company.
There are others such as Public Limited Companies, Private Unlimited Companies and Right-to-Manage Companies, but there’s no need to worry about them. If your business takes off and your empire expands, just get your lawyers to sort it out.
Below is a breakdown of each type of business structure, together with their advantages and disadvantages.
Sole Proprietorship
Setting up as a sole Proprietorship is by far the simplest and most straightforward way of starting a business. You can start up at any time simply by registering your business and there is no fee! The good news is that, after tax, any profits go straight into your pocket. The bad news is that if your business fails you are personally liable for any debts, which means that your house and any other assets can be seized.
The Advantages:
- Fast start-up with no registration fee
- Minimal records and accounting
- Greater flexibility as you can control when and where you work
- Greater privacy as you don’t have to answer to anyone else
- Any profit after taxes is yours and yours alone
The Disadvantages:
- You are personally liable for any debts
- You are solely responsible for all the legal requirements and paperwork that come with submitting your yearly tax bill and paying your own National Insurance Contributions (NICs)
- Premiums for insurances such as life, home, and car are generally higher
Partnership
If you don’t want to go it alone, a business partnership is the next natural progression. In essence, a partnership is two or more self-employed people working together and sharing the workload and any resultant profits.
There are 2 kinds of partnerships; a Limited Liability Partnership (LLP) and a standard partnership. The main difference between a Limited Liability Partnership (LLP) and a standard partnership is that the business is liable for the business’ debts and not the individual partners. This protects partners from personal bankruptcy and debts incurred by other partners, but offer exactly the same tax advantages as a normal partnership.
While it’s not a legal requirement to have a formal agreement in place for a partnership, it is highly advisable to create one. Like any relationship it all starts out with good intentions and a shared vision, but things go wrong, circumstances change and it can all too easily end up in tears.
The Advantages:
- Fast start-up with no registration fee
- No formal agreement required (although recommended)
- Minimal records and accounting
- Someone to bounce ideas off and share the workload
- Shared cost and risk
- Any profit after taxes is shared between the partners
The Disadvantages:
- With a simple partnership, you are not only liable for the overall partnership’s debts but also any debts incurred by other partners regardless of whether you agreed to the expenditure or not.
- Profits are generally shared in equal proportions regardless of the actual working contribution made
- You are jointly responsible for all the legal requirements and paperwork that come with submitting your yearly tax bill and paying your own National Insurance
- Premiums for insurances such as life, home, and car are generally higher.
Private Limited Liability Company
If you really want to protect yourself from any potential business failure, then it may be wise to choose a Private Limited Liability Company. The company is owned by its shareholders, yet it is an entirely separate legal entity and the structure of the company limits the shareholders’ liability to the value of the shares issued. This basically means that if the business goes bust, your personal assets can’t be touched (unless you have been acting illegally…). There is no minimum share capital requirement, but shares cannot be offered to the public and any profit is paid to shareholders in the form of a dividend.
The Advantages:
- Keeps business and personal finances completely separate
- If the business goes bankrupt, you don’t
- Generally regarded as a safer business trading partner than a sole trader or partnership
The Disadvantages:
- Lots of paperwork and lots more rules
