Advantages

Here are some of the advantages of sole trading:

• Autonomy and control: The sole trader is truly independent and is in full control of the business and how it’s conducted and any earned profits. You can therefore fully realise and develop your vision for the business without interference. Great!

• Low administrative burden: The lack of a formal setting-up structure makes for a cost-effective process requiring less paperwork. Usually, you don’t need specialist legal or accountancy advice.
• Less statutory obligations: The Companies Acts don’t apply to sole traders, and you have no requirement to file annual accounts or fulfil the other administrative burdens that fall on limited companies (see the later section ‘Protecting your liability: Limited company’ for details).
• Flexibility: As a sole trader, you can make decisions quickly because you don’t need to consult anyone. Similarly, you can implement new decisions or ideas instantly.
• Personal reputation: A sole trader can build up an invaluable rapport with customers as the ‘face’ of the business.
• Privacy: Personal details of the sole trader, including address and profits, aren’t in the public domain, because you don’t have to register with Companies House (flip to the later ‘Checking Companies House’ section for more details).

• Great for testing a new business idea: Setting up as a sole trader is an inexpensive way to determine whether your business idea has true potential before you leave full-time employment.

  If you’re an employee of someone else though, check that you aren’t breaching your employment contract by, for example, potentially competing with your employer or using confidential information.

• Earning potential: You retain any profits earned as the sole trader and (after tax) don’t have to share them. When you’ve got your cake, you can eat it all yourself!
• Ability to adapt: If you begin your business as a sole trader, you can transition it into a limited liability company (see the ‘Protecting your liability: Limited company’ section later in this chapter) if it expands to a sufficient degree. No bar exists to incorporating the business at a later date by turning it into a limited company.

Disadvantages

Life as a sole trader isn’t all sweetness and light. Here are some of the difficulties you can face:

• Personal liability: As a sole trader you can be held personally liable for losses suffered by the business, because no distinction exists between your personal and business assets. This disadvantage is a real ‘biggie’ – don’t underestimate its significance. If you’re a sole trader, you can end up funding the losses of the business out of your own savings, pension or house. Ouch! For this reason, you need to get your official Terms and Conditions (T&Cs) sorted to minimise your liabilities – check out Chapters 6 and 12 for your website T&Cs and other customer contracts, respectively, whatever business structure you choose.

• Status or prestige: An inherent snobbery exists regarding the sole-trader arrangement. Whether justifiable or not, sole traders are perceived as being less professional in nature and lacking professional credibility. Certain larger companies adhere to a strict policy of only dealing with limited companies.
• Sole burden of responsibility: A sole trader must operate as a ‘jack of all trades’. Whether you have an aptitude for a particular area or not, you’re required to fulfil all aspects of the business, such as administration (invoicing, filing, replying to customer queries and complaints) and finances (tax and National Insurance), as well as carrying responsibility for the core business’s operation. Life can seem like a daily triathlon, followed by a decathlon, followed by a marathon.
• Financial support or funding: Sole traders have to rely on their own personal credit rating when seeking financial support. Potential lenders don’t look on them favourably or as a secure option, which can cause difficulties in getting loans, a mortgage or investment for the business. (Chapter 3 has loads of great tips for early-stage funding).
• Modest profits: The effort you have to expend to achieve a profit can be burdensome when you’re working on your own: achieving a good work–life balance can be difficult, particularly in the initial stages of the business. Your domestic partner may have something to say about this aspect, even if you’re happy with it.
• Unprotected business names: No statutory protection exists for business names of sole traders, because they don’t have to be registered with Companies House, unlike limited companies (flip to the later section ‘Checking Companies House’). Protecting your name is therefore more complicated (see Chapter 8 under the heading ‘Enforcing Unregistered Trademarks’).
• Less social security benefits: A sole trader isn’t entitled to the same social security benefits as employees. Sole traders are classified as ‘self-employed’ and so the amount of National Insurance they pay is usually lower than an employee has to pay. Therefore, if your business as a sole trader gets into trouble and ceases to trade, you can find that you have less entitlements built up to access unemployment assistance and less contributions towards your state pension.

• Insurance: As a sole trader, you usually need public liability insurance if you deal with members of the public. Plus, if you take on even one employee, employer’s liability insurance is also necessary. These kinds of policy can be harder for a sole trader to get than a limited company or partnership – a double whammy given your risk of being personally liable for the losses of the business.

• Harder to exit: If a sole trader wants to sell the business (exit), no shares are available to sell because it’s not a company. All that’s really available is the trading book and reputation you’ve built up as a sole trader. These aspects can be hard to quantify and still harder to sell, because they’re wrapped up in your personality and history.

Advantages

Setting up as a partnership provides a number of advantages. Here are the pros for a General Partnership:

• Simplicity: Relatively simple and straightforward to set up, and doesn’t require a high level of administration or formality.
• Low costs: No great overheads involved.
• Privacy: No requirement to register a General Partnership’s details publicly (as with limited companies) – a distinct advantage because no competitor can access potentially valuable company information.

Now I cover the advantages for both types of partnerships:

• Only two people required: You need only two partners to start and can introduce new ones without difficulty. This arrangement can make decision-making easier than in a limited company (see the later section ‘Protecting your liability: Limited company’) where numerous shareholders may be involved.
• Partnership of equals: Each partner brings a unique set of skills to the business, allowing a well-rounded and balanced business to develop. A partner with a particular aptitude can focus on a certain part of the business while the other partner concentrates on the disciplines where she’s stronger. This type of collaboration allows for greater flexibility in the running of the business.

• Professional requirement: Some professional bodies and associations require that those trading do so via the partnership model: for example, accountancy and engineering firms. Setting up as a partnership enables you to operate in these sectors of business.

Here are some advantages of an LLP compared to a General Partnership:

• Each partner enjoys limited liability against the partnership’s debts: Liability is limited to the amount of capital a person agreed to contribute as part of the partnership agreement – which can be as little as £1 if the partnership doesn’t need capital to run itself. This is a big advantage over a General Partnership.
• The LLP name can be protected: The requirement to register an LLP partnership name ensures that no other company can register the same business name.

Finally, here are some advantages of an LLP over a limited-company structure:

• LLPs retain the organisational flexibility and tax benefits of the traditional partnership structure: They’re easier to set up and run than limited companies and the profits earned aren’t subject to corporation tax, which applies to limited companies.
• No memorandum or articles of association and no holding of LLP meetings required: You don’t need to register the LLP agreement or formulate director or share agreements, as with a limited company.

Disadvantages

Lawyers are fond of saying ‘on the one hand this … on the other hand that’, which can be irritating for clients who just want to be told the right answer. (No wonder that one U.S. President is reputed to have requested in exasperation that he only have to deal with one-armed lawyers, who might give him a single answer!) On the other hand (er, sorry), partnerships entail some genuine disadvantages, and so I look at some of those here:

• No limited liability: A General Partnership (of the traditional, non-LLP kind) has no limited liability. All partners are held personally and jointly responsible for the debts incurred by the partnership. If a partner enters into a contract that’s not in the best interests of the partnership, it’s binding on all the partners, for better or worse.

• The 1890 Act applies if no partnership agreement is entered into: Most General Partnerships are based on a deed of partnership agreement with specific provisions on how the partnership is to be run, in order to avoid the application of this Act. Given that the Act dates from Victorian times, you can imagine that it may have unintended consequences in a modern business environment – after all, it dates from a period when poorhouses were commonplace and so was eating offal!

  For example, under this old-fashioned Act:

  • A partner can’t retire (that is, leave the partnership): If one partner decides to leave, or dies, the partnership has to be dissolved and the assets divided up.

  • A partner can’t be expelled: Again, the partnership has to be dissolved and a new one created.
  • All profits are shared equally: All partners share equally in the profits irrespective of the amount of time or effort they devote to the business.
• Consensus is required: All decisions made require agreement by all partners unless the partnership agreement says otherwise. As such, the decision-making process can become slower and more protracted.
• Shared goals and values are required: Partners may not possess the same vision for the business and can have differing aims and ideas. Because control is shared, this situation can create difficulties in the running of the business.

• Lopsided partnerships: All partners may not apply themselves equally to the diligent operation of the partnership, but may still attempt to direct and manage the business (and take a pro-rata share of any profits). If efforts aren’t rewarded justly, resentment and hostility are likely to grow.

• Lower social security benefits: A partner is entitled to less social security benefits than an ordinary employee. Because the partners are self-employed, they’ll have made fewer contributions than employees of a limited company (for example, National Insurance contributions). Therefore, they have less access to social security benefits such as unemployment assistance and may also have a lower state pension.
• Less obvious ownership and funding opportunities: Generally, all existing partners must agree that someone new can become a partner, and so limited flexibility exists for creating additional ownership opportunities. The partnership structure is also less suitable on the whole (compared to limited companies) for raising finance, which is why most of the capital from partnerships tends to come from the partners themselves. Chapters 3 and 4 discuss your funding options and associated legalities.
• Limited Liability Partnerships: Though not as onerous as for a limited company, the administrative burden is much greater for an LLP than for a General Partnership. Registration with Companies House is required, as is the filing of annual accounts and returns and any changes to business names, addresses or members. Penalties may be imposed for late filing and, unlike some soccer referees, Companies House is always happy to award a penalty (see the later section, ‘Checking Companies House’). I look at these formalities in Chapter 2.

Advantages

The protection from personal liability means that limited companies are the safest of the three types of business structure I discuss in this chapter. Here are some of the advantages of establishing a limited company in more detail:

• Distinct entity: A limited company is a discrete legal entity, completely separate from the people who run it. This arrangement provides security for company employees and members, because it exists beyond the life of its members. This setup is in stark contrast to the case of sole traders (read the earlier ‘Going it alone: Sole trader’ section) and General Partnerships, where no such separation exists (other than for the newer LLPs; see the earlier section ‘Collaborating with a colleague: Partnership’).

• Limited liability: Shareholders are liable only for any debt the company accrues according to the nominal value of their own shares. Their personal assets aren’t at risk if the business gets into difficulty, which can occur with sole traders. I provide a number of tips to reduce your business risks in Chapter 14.

• Clarity from the Articles of Association (the company’s constitution): These clearly set out the powers and responsibilities with which the company, the shareholders and directors must comply. I describe Articles of Association further in Chapter 2. The provision of a formal structure to trade under gives confidence and security to those involved and allows decision-making to take place relatively quickly and effectively and without undue difficulties.
• Company name protection: All limited companies are required to register a company name with Companies House (see the later section, ‘Checking Companies House’). When registered, this name is protected from that date, though only as a limited company name – it doesn’t have the same wider protection as a trademark (more on this important difference later in ‘Looking into trademark registers’).

• Taxation benefits: Limited companies are taxed only on their profits and, as such, aren’t subject to the higher (personal) tax placed on sole traders or partnerships. The ability of members to pay themselves in the form of dividends rather than as a salary enables them to manage their tax liability and potentially save on National Insurance contributions.

• Employee benefits: A limited company can offer its employees an opportunity to purchase shares in the company (see Chapter 5), helping it to attract key personnel with an interest in the growth of the company. This benefit can also have positive tax implications for the company and employees. I provide more information on employees generally in Chapter 5 and on a company’s responsibilities to them in Chapter 7.
• Pensions: Starting from October, 2012, companies have an obligation to establish an approved pension scheme, which provides greater benefits than ordinary self-employed pension schemes and provides tax savings for both parties. (See Chapter 5 for more details about complying with pensions law.)
• Credibility: Going through the incorporation process increases the perceived credibility of the enterprise in the marketplace. Many large companies have a policy of dealing only with limited companies.

• Cost-effectiveness: The initial cost involved in setting up a limited company isn’t particularly high, because you can complete the whole process online.

• Investment and funding: If a company needs to raise capital it can do so by issuing new shares and differing types of shares. In order to attract outside investors, operation as a limited company is nearly always a mandatory requirement in order to be taken seriously. Chapter 3 covers finding funding partners and Chapter 4 delves into funding agreements.
• Continuity: A company ceases to exist only if it’s formally wound up or struck off the Companies Registry at Companies House. If a shareholder or director wants to leave, retire or sell his shareholding, or he dies, procedures in the company’s Articles or its Shareholder Agreement cover these events, and the company can continue regardless.

Disadvantages

The protection that you receive as a limited company doesn’t come without effort: the requirement to pay attention to 900 sections and schedules of the Companies Act is enough reading to cure anyone of insomnia! In fact research shows that of the 229,961 hours that an average human spends sleeping in her lifetime, at least 10 per cent can be attributed to reading the Companies Act! Here are some of the problems:

• Administrative burden: The rules governing limited companies are more complex and restrictive in nature than those applicable to sole traders, General Partnerships or LLPs. A number of legalities are involved in creating and registering a new limited company: registration with Companies House; filing of annual accounts and returns; and arranging the payment of corporation tax, National Insurance, income tax obligations and possibly Value-Added Tax (VAT). Additionally, all limited companies must conduct an external audit of their accounts on an annual basis (unless the requirements of the small company exemption are met — see Chapter 2). All this paperwork takes up time, which is often the most precious of SME resources.

• Ongoing costs: Although limited companies are cheap to set up, the annual duty to file accounts and returns in a prescribed format means that you have to maintain proper financial records at all times. The ongoing nature of these statutory duties means that the cost of complying is significant and usually requires the appointment of an accountant or an accountancy service.

• Privacy: Information relating to the private company is on public file after it’s registered, including information on the company’s accounts, shares and directors. Although this transparency can be an advantage when seeking credit, the company has no control over who can access this information. If you browse the Internet you may be surprised to find numerous public databases with which you’ve had no contact featuring your company details.

• Liability: Companies come with limited liability, but that doesn’t mean you’re home free. Although courts have always been reluctant to make individuals controlling the company responsible for its actions, in exceptional circumstances the courts do ‘lift the corporate veil’ to get at those responsible for wrongdoing. Examples are when a company is being used primarily as a vehicle of fraud or if one company is simply acting as the agent of its (wrongdoing) parent company.

• Director liability: Statutory instances exist where members or directors of limited companies can be held personally responsible for their actions or liable for company debts. Directors can be personally liable under the Companies Act, 2006 if they breach any of their seven core responsibilities:

  • To act within the powers conferred by the company’s constitution
  • To promote the success of the company for the benefit of its members
  • To exercise independent judgement
  • To exercise reasonable care and skill
  • To avoid conflicts of interest
  • Not to accept benefits from third parties
  • To declare an interest in a proposed transaction or arrangement (which means, for example, that they must give notice of any benefit they may get from a contract the company is planning to enter into)

  Directors can also be liable under the Insolvency Act, 1986 (if they’re guilty of wrongful trading where they knew the company had no prospect of avoiding insolvency. They can also be guilty of fraudulent trading if they attempt to defraud creditors – this is a criminal offence).

  Directors can also be liable under the Company Directors Disqualification Act, 1986 (a disqualified director who doesn’t obey a disqualification order is liable for company debts incurred while so acting; this disobedience is also a criminal offence). Reasons for which directors can be disqualified include:

  • Persistent breaches of the Companies Act relating to filing and accounts
  • Committing fraud when the company is being wound up
  • Engaging in fraudulent trading

Ignorance of the law is no excuse and so pay attention to these obligations. Realistically, you require professional help from an accountant and/or a lawyer to make sure that you don’t trip up over any of these disadvantages. Limited Liability Partnerships (see the earlier section ‘Collaborating with a colleague: Partnership’) offer a good halfway house, because they’re a bit easier to run than a limited company from a regulatory point of view. But a limited company, with the ability to create and allocate shares, offers broader opportunities to increase the number of owners and raise investment.