Legal structures: the basics

A sole trader is a self-employed individual, who is the 'sole' owner of their own business. Being a sole trader is the simplest and most common way to set up and run a small business and start working for yourself.

To become a sole trader, you do not need to register your company with Companies House - you just register as self-employed through HMRC and pay tax through self-assessment. You also do not need to file confirmation statements or full accounts with Companies House every year.

As the sole owner of your business, all business decisions are made by you, and all of the business's profits (after tax) are yours - there are no other company directors, shareholders, or partners. However, as a sole trader your business is not considered to be a separate legal entity from you - you are your business. This means that you are personally liable for any losses, debts and liabilities your business incurs. Your personal assets (like your home and savings) could be at risk if you cannot pay your debts, which make this a risky option for businesses that need a lot of investment. Being a sole trader can also make it harder to raise capital.

Find out more about setting up as a sole trader in our guide or see Gov.uk for more information.

Your responsibilities as a sole trader

As a sole trader you are responsible for the proper running of your business and meeting all of the legal requirements that are relevant to you - in your business administration, insurance, in hiring, paying and managing staff, and in your business operations. You are also responsible for filling in your self-assessment tax return and paying all of the National Insurance and Income Tax that you are due.

Your responsibilities include:

• Letting HMRC know that you're self employed when you start trading
• Filling in your Self Assessment tax return with HMRC every year by the deadline to ensure you pay all income tax due on your profits and your Class 2 and Class 4 National Insurance
• Register as an employer with HMRC if you take on eligible staff and operate a 'Pay as you earn' (PAYE) payroll scheme to ensure you collect the correct amount of income tax and national insurance from staff for you to pay to HMRC
• Keeping accurate and representative records for your business depending on your accounting basis and keep accurate records of your expenses
• Registering for VAT or for the Construction Industry Scheme if applicable to your business.

Sole trader pros and cons

There are many advantages to becoming a sole trader. These include:

• Simple to start up: Becoming a sole trader has lower start up costs and is the easiest way to start your business
• More simple legal structure: On an ongoing basis you do not need to file annual confirmation statements, formal corporate tax returns or full annual accounts with Companies House. (You still need to keep accurate records of your invoices, income, expenses, etc and file your self-assessment tax returns)
• Full control: You are in control of all of the decisions you make for your business as the business owner
• Your profits: All of profits after tax come to you as the sole business owner
• Can change structure as you grow: As your business grows, you may decide to change your business structure and set up as a limited company.

However, there are also disadvantages to being a sole trader. These include:

• Unlimited personal liability: As a sole trader, you are personally responsible for all of the losses, debts or liabilities of your business as you and your business are considered one legal entity. If your business fails, your personal assets could be at risk. For businesses that require big investment, opting to be a sole trader can be very risky.
• Raising finance more difficult: As a sole trader it can be harder to raise large amounts of money to fund your business. As there is less accounting transparency and more personal responsibility with sole trader businesses, banks can be more reluctant to loan large sums to sole traders. You also don't have any shares to sell or exchange for investment in the business.
• Legacy issues: If you have to stop working (e.g. through death, retirement, or ill-health) then your business also ceases to trade, as you are your business. It can also be harder to sell a sole trader business.

Sole trader business examples

If you want to be self-employed and want to quickly set up and run your business working for yourself, setting up as a sole trader can be an excellent choice. This legal structure can work well for people:

• offering a service such as caterers, cleaners, make-up artists, photographers, dog-walkers, book-keepers, etc
  
• working as an individual trades person, such as plasterers, electricians, plumbers, tilers, gardeners, etc
• working as freelancers or contractors

If you are unsure whether this legal structure is right for your business, seek advice from an accountant or legal professional, or talk to your local Business Gateway office.

There are three types of partnership:

• General or 'ordinary' partnerships
• Limited partnerships
• Limited liability partnerships (LLPs)

It's a good idea to draw up a written agreement between the partners. For further advice, consult an accountant or solicitor.

General or 'ordinary' partnerships

A general partnership is a relatively simple and flexible way for two or more people to own and run a business together. Similar to a sole trader for individual business owners, a general partnership has no legal existence distinct from the partners themselves. If one of the partners resigns, dies or goes bankrupt, the partnership must be dissolved, although the business can still continue. It is important to draw up a partnership agreement, to detail the terms and arrangements of the partnership.

Ordinary partnerships do not need to register with Companies House, or file annual statements and accounts with them. However a general partnership does have to be registered with HMRC for tax purposes. The nominated partner does this by registering the partnership with HMRC and then each partner must also register for Self Assessment. Note that the partnership itself isn't taxed, each partner pays tax via self assessment.

The partners are jointly liable for any amounts owed by the partnership and so are equally responsible for paying off the whole debt. Creditors can claim a partner's personal assets to pay off any debts - even those debts caused by other partners.

If a partner leaves the partnership, the remaining partners may be liable for the entire debt of the partnership. Partners do not enjoy any protection if the business fails.

For more information see Gov.uk.

General partnership responsibilities

Similar to a sole trader, in a general partnership you and your partner(s) are responsible for the proper running of your business and meeting all of the legal requirements that are relevant to you in the setting up and running of your business.

Your responsibilities include:

• The nominated partner must register the partnership with HMRC, and the remaining partners must register themselves as partners separately.
• The nominated partner must also send the partnership tax return to HMRC each year declaring the income, or losses, of the partnership and detailing how the profit and any losses has been split
• The nominated partner is also responsible for reporting key changes to the partnership, such as updates to a partner's address, change to who the nominated partner is, etc
• Each partner must register for self assessment and fill in their Self Assessment tax return with HMRC every year by the deadline to ensure you all pay the income tax due on your profits and your Class 2 and Class 4 National Insurance
• If you take on eligible staff you will need to register as an employer with HMRC and operate a 'Pay as you earn' (PAYE) payroll scheme to ensure you deduct income tax and national insurance from staff and pay this to HMRC
• Keep accurate and representative records for your business depending on your accounting basis and keep accurate records of your expenses
• Register for VAT or for the Construction Industry Scheme if applicable to your business.

General partnership pros and cons

Similar to sole traders, general partnerships have some advantages:

• Easy to start up: You don't need to register or incorporate with Companies House
• Simple admin: On an ongoing basis you do not need to file annual confirmation statements, formal corporate tax returns or full annual accounts with Companies House. (You still need to keep accurate records, file partnership tax returns, and each partner must file self assessment tax returns)
• Partner control: With no stakeholders or directors you and your partners are in control of the business and you can customise the terms of the partnership with a partnership agreement
• Your profits: All of profits after tax are split among the partners as per the agreement
• Less formality: It is a less formal partnership than an LLP, which can suits some small businesses.

However, there are also disadvantages to general partnerships. These include:

• Unlimited joint personal liability: A huge disadvantage is the fact that partners have unlimited personal liability and are personally responsible for all of the losses, debts or liabilities of the business. If the business fails, partners' personal assets would be at risk. Furthermore, each partner is liable for the activity of the other partners, which can make this structure more risky
• Risk of dissolution: If one partner leaves then this dissolves the partnership
• Raising finance more difficult: Again it can be harder to raise large amounts of money to fund your business. There is less accounting transparency and more personal responsibility which means banks can be more reluctant to loan large sums to sole traders. You also don't have any shares to sell or exchange for investment in the business.
• Disagreement: Disagreements among partners can risk the entire business and could result in losses or cease of trading.
• Too simple a structure for a large company: If your company grows or gets more complex, the simplicity of this legal structure and the personal liability on the partners is likely to become to an issue.

General partnership business examples

If you and one or more associates want to quickly set up and run a small business working for yourselves, setting up as a general partnership could be an option - particularly if your business requires only a small amount of investment and is unlikely to incur large liabilities. This legal structure can work for people:

• offering a joint service such as cleaners, hair and make-up artists, interior design, photographers, caterers, etc
• working as freelancers or contractors
• working as trades people, such as plasterers, plumbers, decorators, tilers, gardeners, etc

If you are unsure whether this legal structure is right for your business, seek advice from an accountant or legal professional, or talk to your local Business Gateway office.

Limited partnerships

A limited partnership is made up of a mixture of general partners and limited partners. General partners are responsible for the full day to day running of the business - but also have full unlimited liability for the partnership's debt, losses and obligations. Limited partners are only liable for the debts or obligations that they initially invest in the business, but cannot participate in the management of the business. Partners can be either an individual person or a legal body like a company.

Scottish limited partnerships are distinct from those in the rest of the UK, as Scottish limited partnerships are considered as a legal entity, separate from each partner. (Note that the government is introducing reforms to limited partnerships to tighten requirements and update the legislation).

Limited partnerships must register with Companies House and Scottish limited partnerships need to provide additional details about the partners and persons with significant control and file confirmation statements each year. Limited partnerships do not usually pay corporation tax and don't generally have to make an annual return or file accounts (unless the general partner is a limited company). Like general partnerships, profits are shared amongst the members and the partners pay tax on income or gains.

When they receive the registration Companies House inform HMRC that the limited partnership has been set up. HMRC will set up the partnership's tax records so there is no need to register with them.

General partners are jointly liable for any debts owed by the partnership and so are equally responsible for paying off the whole debt. A limited partner's liability is limited to the amount of money they have invested in the business. It's also limited to any personal guarantees they have given to raise finance.

Find out more about setting up as a limited partnership in our guide or visit Gov.uk.

Limited partnership responsibilities

There are specific responsibilities associated with running a limited partnership.

Your responsibilities include:

• The general partner must register the partnership with Companies House, and provide the necessary details on all partners and persons/entities with significant control which all partners must sign
• It is the legal responsibility of the partnership to investigate and obtain information on all partners and entities with significant control
• A confirmation statement must be filed every year with Companies House and you must notify Companies House of any changes to your Scottish limited partnership or any changes to persons or entities with significant control
• Once the limited partnership is registered, Companies House will alert HMRC who will then set up the partnership's tax records.
• Each partner in the limited partnership must register with HMRC separately to get their own tax records set up to ensure they all pay the income tax due on your profits and your National Insurance contributions
• The nominated general partner will also need to complete a Self Assessment tax return for the partnership every year.
• If you take on eligible staff you will need to register as an employer with HMRC and operate a 'Pay as you earn' (PAYE) payroll scheme to ensure you deduct income tax and national insurance from staff and pay this to HMRC
• As part of the running of the business the partnership must keep accurate and representative records for your business and expenses
• The partnership must register for VAT or for the Construction Industry Scheme if applicable to the business.
• The general partner(s) must act for the business if it’s wound up and dissolved

Limited partnership pros and cons

Limited partnerships have some advantages:

• Access to funding: A limited partnerships can often be an attractive structure for achieving large levels of investment as they offer lower risk for investors and require a lower level of hands on involvement in the running of the business.
• Limited liability for limited partners: The liabilities of the investors are limited to the sum of the assets they contributed.
• Full control for general partners: This structure allows general partners to gain investment, while keeping full control of the management of the business.
• Tax structure: Limited partnerships have a simpler tax structure, as partners pay the taxes on their own tax returns, as opposed to through the partnership itself.

However, there are also disadvantages to limited partnerships. These include:

• Liability for general partners: General partners take on all of the business risk, as their liability is unlimited. This means that if the business fails their personal and other business assets could be at risk.
• Lack of control for limited partners: The limited partners do not have any say in the way that the partnership is run, and are unable to remove their original contribution of funds.

Limited partnership business examples

Limited partnerships are often used as vehicles for investment, to pool the assets of individuals and entities and enable investment, but to allow the management of the business to be controlled by the founders. This legal structure could work for:

• venture capital, private equity, or pension funds
• businesses holding commercial property
• the funding of creative ventures, such as theatre or film productions
• businesses with large start up costs or high overheads, such as restaurants, bars or hotels or environmental start ups that require a lot of equipment

If you are unsure whether this legal structure is right for your business, seek advice from an accountant or legal professional, or talk to your local Business Gateway office.

Limited liability partnerships (LLPs)

Limited liability partnerships are legal entities that run in a similar way to general partnerships, but limit the personal liability of the partners, meaning the partners aren't personally liable for the business debts and losses.

LLPs are more complicated to set up and run than general partnerships. They have to meet many of the same requirements as limited companies - they need to be registered with Companies House and must file annual confirmation statements and full annual accounts with them. LLPs are designed to be used by profit-making businesses

An LLP must have at least two designated members - the law places extra responsibilities on them, and can have any number of ordinary members. If for any reason the number of designated members falls to one, every member is deemed to be a designated member. Members should make an LLP agreement as part of setting up the partnership.

LLP's are not usually taxed as an entity and generally do not pay corporation tax - each member pays tax on the profits they receive.

Find out more about setting up as a LLP in our guide, or visit Gov.uk for more information.

Limited liability partnership responsibilities

There are specific responsibilities associated with setting up and running a limited liability partnership.

Your responsibilities include:

• Designated members must register the partnership with Companies House
• Designated members must register the partnership business for self assessment with HMRC - and register separately as individuals
• Each ordinary member must also register with HMRC separately to get their own tax records set up to pay via self assessment ensure you all pay the income tax due on your profits and your National Insurance contributions
• All members should make an LLP agreement, detailing how profits will be shared and distributed, members' responsibilities, process for joining or leaving the LLP, decision process, etc
• A confirmation statement must be filed every year with Companies House and designated members must notify Companies House of any changes to the partnership
• Annual accounts must be prepared, signed and submitted to Companies House each year
• The designated partners need to complete a Self Assessment tax return for the partnership every year.
• If the LLP takes on eligible staff you will need to register as an employer with HMRC and operate a 'Pay as you earn' (PAYE) payroll scheme to ensure you deduct income tax and national insurance from staff and pay this to HMRC
• As part of the running of the business the LLP must keep accurate and representative records for your business and expenses
• The LLP must register for VAT or for the Construction Industry Scheme if applicable to the business.
• The designated partners must act for the business if it’s wound up and dissolved

Limited liability partnership pros and cons

Limited liability partnerships have some advantages:

• Limited liability for partners: A partner's liability is generally limited to the amount of money they have invested in the business. It is also limited to any personal guarantees they have given to raise finance. This means that members have some protection if the business runs into trouble, so individual members are not usually personally liable for business debts or losses. Also individual partners generally aren't responsible for the actions of the other partners
• Flexible management and control for partners: This structure allows partners to determine their own partnership agreement and outline their own internal processes, rules, and decision-making.
• Tax structure: Limited liability partnerships have a simpler tax structure, as partners pay the taxes on their own tax returns, as opposed to through the partnership itself.

However, there are also disadvantages to limited liability partnerships. These include:

• Dependent on other partners : LLPs can only exist with two or more members. This means if your partner or partners leave, the partnership would be dissolved - so you must be able to depend on the dedication of your partners.
• More complex: The incorporation and administration of the business is more complex that a general partnership.

Limited liability partnership business examples

Limited liability partnerships are often used by professional firms where multiple partners are involved in the business. This legal structure could work for:

• professional services such as legal firms or accounting firms
• medical practices such as doctors or dental practices
• some family firms

If you are unsure whether this legal structure is right for your business, seek advice from an accountant or legal professional, or talk to your local Business Gateway office.

A limited company, or private limited company, (ltd), is a business that owned by shareholders and is considered as a separate legal entity from its shareholders and directors. This means that the company exists in its own right. It also means that the liability of the shareholders or directors of the company is limited, i.e. you are not personally liable for the company's debts and losses.

Setting up a private limited company is a common way to set up a business in the UK. Generally these companies are 'limited by shares' - which usually means that they are 'for profit'. (Limited companies can also be 'limited by guarantee', which are usually 'not for profit' companies, however in this article we will be focusing on for profit companies limited by shares).

With a private limited company you must have at least one director (someone who runs the business), and at least one shareholder (someone who owns the business). Shareholders can also be directors so these can be the same person.

The director (or the board of directors) makes the management decisions. Directors may also be shareholders. Finance comes from shareholders, loans and retained profits. Any profits are usually distributed to shareholders in the form of dividends, apart from profits retained in the business as working capital.

Limited companies are legally required to register with Companies House and regularly file information with them. That information given to Companies House is public and is able to be viewed by anyone. Limited companies must also register with HMRC to pay corporation tax (which is often done when registering with Companies House). Limited companies have a more complex to set up than sole traders or partnerships, as you must file more information with Companies House and HMRC.

Company directors are an office holder of the company and therefore regarded as an employed earner for the purposes of paying National Insurance contributions (NICs). As such, company directors must pay both Income Tax and Class 1 NICs on their director's earnings, and tax on any dividends.

You can incorporate your company yourself, or there are numerous businesses that can help you incorporate a limited company. You can also speak to an accountant of legal professional for help.

Find out more about setting up a limited company on the UK Gov site.

Your responsibilities as a limited company

The directors of a limited company are responsible for the proper running of the business and meeting all of the legal requirements that are relevant - in your business administration, insurance, in hiring, paying and managing staff, and in your business operations.

Director's responsibilities include:

• Registering the company with Companies House and registering for corporation tax with HMRC (which is often done during registration, but can also be done separately through HMRC)
• Uploading a ‘memorandum of association’ during registration, which is a legal statement that must be signed by all initial shareholders agreeing to form the company. If you are registering with Companies House online it will be created automatically.
• Creating and uploading ‘articles of association’ during registration - which are written rules about the running of your company which must be agreed by all shareholders, directors and the company secretary (if you have appointed one). You can use standard articles or create your own (note you cannot use standard articles if you're setting up a community interest company).
• Deciding your shares, including determining share type and issuing the shares - most companies have 'ordinary' shares, which mean shareholders get payments through dividends and get one vote per share they own. You can price your initial shares however you like, but bear in mind that shareholders need to pay for their shares in full if the business closes. Many people set shares to the value of £1
• Providing Companies House with a 'statement of capital' which provides information about the company's shares, including: the number and type of shares the company has and the total value and details of all of the shareholders
• Providing details of the ‘prescribed particulars’, which lays out the rights of each share type. This has to include details on the share of dividends, whether shares can be redeemed for money, and voting rights
• Identifying your company's persons with significant control (PSC) and giving their details to Companies House - these details must be recorded on your PSC register, and when you incorporate your company.
• Keeping accurate and representative records for your business, including records about the company and your financial and accounting records, and also meeting minutes and records of key decisions made by shareholders and directors
• Filing your company tax return and annual accounts at the end of each financial year
• Paying corporation tax for all of the company's profits and filing the company's tax return on time
• Reporting changes of your company details to HMRC and Companies House if necessary, e.g. a change in director contact details, registered office, the appointment of a new accountant or tax adviser, appointment of new company secretary, etc
• Filing a confirmation statement each year with Companies House
• Registering for VAT or for the Construction Industry Scheme if applicable to your business.
• Registering as an employer with HMRC and operate a 'Pay as you earn' (PAYE) payroll scheme (even if you are only employing yourself as a 'director'). PAYE will help ensure you collect the correct amount of income tax and national insurance from employees for you to pay to HMRC
• You must also pay your own tax on earnings and dividends through PAYE and self assessment if necessary

Limited company pros and cons

Limited companies have some advantages:

• Limited liability for owners: A key benefit to setting up a limited company is the fact that your liability is limited to the amount paid for your shares. This means that directors and shareholders are not personally liable for the company's debts, losses or other liabilities and that their personal finances are protected (except in cases of fraud). If your company requires large investment, deals with high value items, or provides a service that could result in high liability claims, this limited liability is especially important.
  
• Succession planning: A limited company is a separate legal entity in its own right, which means that the company can survive even if directors and shareholders leave, retire, die, etc. This gives more security to the company's longevity and to employees
• Easier to sell: A limited company is much easier to sell than other business types (such as a sole trader business) as it exists separately from the owners. This means contracts are entered into with the business, rather than the owners, and that ownership can be changes through the sale of shares
• Finance opportunities: It can be easier to raise finance for a limited company. This is because banks can often see a limited company as lower risk than a sole trader. Limited companies can also raise capital by bring in investment by selling shares to new investors
• More credibility: Limited companies are often regarded as more credible businesses than sole traders. This is because there is more transparency to the business and its owners, through filings in Companies House. Often larger businesses or organisations will not deal with companies that are not limited due to risks involved from unlimited liability.

However, there are also disadvantages to limited companies. These include:

• More complex: The incorporation and administration of the limited companies are more complex, and you may need to appoint an accountant to help with your tax filings and even legal professionals. You may also benefit from using accounting software such as Free Agent and Xero to help with your accounts and financial records.
• Legal requirements: There are more legal requirements of company directors, including the keeping of accurate records, the filing of annual statements and company records, the filing of full company accounts, etc
• Public record: Details of a limited company and its directors and shareholders are public records and are able to be viewed by anyone.

Limited company business examples

Limited companies can be used by any business, both small and large, in any almost any industry. This legal structure could work for:

• companies that require high levels of investment, work with high value goods or services and companies that could be subject to high liability claims - such as building contractors, larger trades companies, jewellers, IT contractors, manufacturers, FMCG, online retailers, etc
• companies planning to offer services to larger organisations or the public sector
• sole trader firms that have grown since start up
• companies hoping to grow quickly
• start ups that require investment

If you are unsure whether this legal structure is right for your business, seek advice from an accountant or legal professional, or talk to your local Business Gateway office.

A note on private unlimited companies

A private unlimited company is a type of private company that has no limit on the liability of its owners. They do not need to disclose as much financial information as the owners do not have limited liability.

It may or may not have share capital. Such companies are very rare in the UK and are usually created only for specific reasons. It is strongly recommended that you take legal advice before creating one.