Structural options – what's the best legal structure for your start-up?
One of the first and biggest legal decisions that you have to make when starting up is what structure your business should take. There are many different options available and your chosen structure can affect many aspects of your business such as taxes, liability and exit strategy.
In one of our earlier blogs, we wrote about creating your company (explaining the process of registration), so depending on which structure you choose, there may be certain filings you need to make at Companies House and HMRC - these vary from very few to a lot! Each legal structure has advantages and disadvantages, so with your future goals in mind, consider which best suits your business now and going forward.
Firstly, let's cover off a few things...
- It's unlikely that as a start-up you will form a public limited company (PLC). These are typically for larger companies and have to have a minimum share capital of £50,000!
- You may also have heard of community interest companies (CICs) which exist for the benefit of the community rather than private shareholders. We are not covering this type of structure in our article. But just to give you a bit of context (as some start-ups do operate in this way), there are strict rules around CICs. You need to include a community interest statement when you apply to be registered and you must first get your company approved by the community interest company regulator. There are also co-operative or community benefit societies. A co-operative society is a group of people acting together to meet the common needs and aspirations of its members, sharing ownership and making decisions democratically. They are not about making big profits for shareholders but creating value for customers. A community benefit society is run primarily for the benefit of the community rather than its members.
- So depending on the mission of your start-up, one of these structures may be more appropriate, however, you should speak to an expert first before making any decision on what structure works best for your business.
So what are your options in the UK?
A sole trader: this is the easiest and quickest way to operate and is an option where there is one individual who is the sole owner of the business; if there is more than one founder, this structure will not be appropriate There are no fees to register and subject to any operational constraints, you can go out and start business straight away. However, beware that there is no limitation on your liability. This means that if something were to go wrong, you could end up being personally liable. Sole traders are typically used by businesses where the founder is very closely connected to the brand. As a sole trader, the individual is self-employed and can easily withdraw money from the business.
A partnership: this is between two or more individuals, so if there are a few of you that are going into business together, this may be a good idea as you are all invested in the business. Not everyone has the skills to run a business by themselves and being in partnership means you can support and help each other. The more partners that there are in a partnership, the more complex decision-making becomes as more people will want to be heard. If partners all agree, decision-making can be straight forward, but if they disagree, things may become difficult. As with sole traders, all partners are responsible for all the debts owed by the business. This applies to all debts, not just to ones that you personally incur. It is often said that a business partnership is like a marriage – so you need to fully trust who you go into business with (and do your diligence if needed) as you could be personally liable for what they do. Although not a legal requirement, there is usually a partnership agreement that will govern things like what profits each partner gets and what happens if one of the partners wants to leave.
A private company limited by shares: this is one of the most common legal entities and means that the shareholder's liability is limited to the amount unpaid (if any) on their shares. The company is registered at Companies House and must therefore abide by certain regulations and filing requirements. This means that annual accounts, directorships and any further shares that are issued in the company will need to be filed and all this information is publicly available. The company needs to have at least one director and one shareholder. Your company will have a separate legal personality meaning it can enter into contracts in its own capacity. Investors may be more likely to invest in a private limited company as they have limited liability too. Depending on any contractual provisions in a company's articles of association or shareholders' agreement, the transfer of shares can be straight forward. In order to extract profits from the company, the directors will need to declare, and the shareholders will need to approve, a dividend. There are stringent rules about how dividends can be declared so it is not always straightforward to extract profits.
Limited liability partnership (LLP): this type of structure is often described as a hybrid between a private limited company and a partnership. The owners of the LLP are often called members and usually there will be a members' agreement that governs the relationship between the parties. A member's liability is limited to the amount that it has contributed to the LLP. The LLP also needs to be registered at Companies House. A big difference between a private company and an LLP is that an LLP does not have any shares. So if you are planning on issuing shares in return for future investment, this may not be the best structure for your business. As with a private company limited by shares, an LLP has a separate legal personality. An LLP must have at least two members so if one wanted to leave, the LLP would need to find another member to be brought in or the LLP would need to be dissolved.
So when it comes down to deciding what's best for you – one size doesn’t fit all. There's really no 'single best' option so consider the pro's and con's before embarking on this journey - it's the start of many more decisions to come.
Please contact the Trowers’ team for more information. We have also produced a series of fact sheets to help you, so click here to access our online resources.