The definitive guide on how to structure your business
If you’re planning to start out on your own, one of the most important decisions you’ll need to make is figuring out how you should structure your business.
As a freelancer, contractor or small business owner, there are three main types of legal structures you should consider:
It’s a decision that requires careful consideration, and it’s important that you seek advice from qualified professionals when you weigh out the pros and cons of each legal structure. To begin with, you need to have a good grasp of the basics—and here’s where our guide comes into the picture.
As a sole trader, you run and control your company as an individual, and are considered a self-employed person. You’re personally responsible for the decisions, as well as profits or losses of the business. Sole traders can hold a variety of professions—from electricians and plumbers, to graphic designers and software developers.
A limited company is a type of business structure where the company has its own legal identity. The assets and liabilities of the company are separate from the personal finances of its owner; as a director and shareholder, you can’t withdraw money out of your business as and when you want to, and profits that are made belong to the company. Even if an individual is the only shareholder and director, the company is still a separate legal entity.
An umbrella company acts as an intermediary between a contractor or freelancer and their agency or client. This means that the agency or end client engages with the umbrella company, rather than directly with the contractor or freelancer.
If you decide to work through an umbrella company, you’ll be considered an employee. You’re not in charge of managing your payroll, and will instead submit a timesheet and expenses information to the umbrella company on a monthly basis. The company will also handle your tax, pension and National Insurance contributions, and you’re also entitled to statutory employment benefits, such as holiday pay and sick pay.
Here are a few downsides to becoming a sole trader:
Here are a few downsides to operating a limited company:
Here are a few downsides to working through an umbrella company:
Lack of control: You’re not able to enjoy the same level of freedom as you would operating as a sole trader or through a limited company. You’ll have less control over a variety of aspects—from taxation, to when and how much you’re paid.
When deciding between the different business structures, there are various commercial and tax-related factors you need to consider. Below, we’ve elaborated on three key factors you need to evaluate:
“To what extent do I need to be protected from legal liability?” is an important question that all business owners need to evaluate.
In an Entrepreneur article, Mark Kalish, co-owner of EnviroTech Coating Systems Inc. further elaborates: ‘You need to consider whether your business lends itself to potential liability and, if so, if you can personally afford the risk of that liability.”
He shares an example: in setting up EnviroTech, Kalish and his co-founder had made a sizable investment in equipment, and had important contracts to fulfil. As such, they decided to incorporate, as they didn’t want to take on personal liability in the event that their company incurred losses.
The initial stages of setting up your business can feel scary, exciting and all consuming—and leaves little time for you to reflect on longer term goals, or to question yourself about what your business might be like in five or ten years.
For instance, what will happen to your company if you’re no longer around to run it? A sole proprietorship will be legally dissolved upon the death of its owner, while a limited company will continue its operation as the shares can be distributed to family members or to the remaining shareholders.
Other important questions you need to consider include: What are your funding needs and options for obtaining financing a few years down the road? Do you plan to sell your partnership share, buyout a partner or bring in additional stockholders as you expand?
In discussing the pros and cons of operating as a limited company above, we’ve highlighted one of the downsides it presents—which is increased legal and administrative requirements.
Managing these aspects can be challenging, particularly for time-pressed business owners juggling between multiple roles. Before you incorporate your business, it’s important that you ensure you have the time, ability and manpower resources to meet the stringent record keeping and reporting requirements imposed by HMRC and Companies House.
Kalish shares a word of advice: "I would always take sole proprietorship as a first option. If you're the sole proprietor and you own 100 percent of the business, and you're not in a business where a good umbrella insurance policy couldn't take care of potential liability problems, I would recommend a sole proprietorship. There's no real reason to encumber yourself with all the reporting requirements of a corporation unless you're benefiting from tax implications or protection from liability."