Which business structure to choose in the UK: sole trader, partnership or limited company

If you are starting a business in the UK, or you are a sole trader wondering whether to switch to a limited company, the first decision is which business structure to use. There are three main options: the sole trader, the partnership and the limited company. Each one changes how much of your personal money is at risk, how you are taxed and how much paperwork you take on. This article walks through the three structures, their pros and cons, and the kind of business each one tends to suit.

Main types of business structure in the UK

In the UK there are three main kinds of business structure:

• the sole trader;
• the partnership (of which there are three types); and
• the limited company, also known as the Ltd.

There are other kinds of structure too, such as charities, publicly listed companies and companies limited by guarantee. Those are outside the scope of this article. For most people starting out, the real choice is between the three above.

Sole trader: pros, cons and liability

The sole trader is the simplest of all the business structures. You do not need to register as a company. There are no forms to fill out and no fees to pay. You simply start trading.

That simplicity comes at a price. As a sole trader you are personally liable for the debts that you incur in the business. There is no separation between you and the business, so if the business cannot pay what it owes, your personal assets are at risk, including your home or your car.

You will also pay personal income tax on the money that the business generates. The business is not taxed separately from you; its income is your income.

So the sole trader route is quick and cheap to start, but you carry all of the risk personally.

Partnerships: general, limited and LLP

An alternative to trading as a sole trader is a partnership. Partnerships are a good option for people who want to work together with others, pool their money, pool their skills and jointly make a profit.

There are three main kinds of partnership in the UK, and the difference between them is liability.

• General partnership. All of the partners have unlimited liability. Like a sole trader, each partner can be held personally liable for the debts and costs of the business.
• Limited partnership. At least one of the partners has unlimited liability, while at least one other partner has limited liability. The limited partner is only risking the money they have invested in the partnership. If they invested £100, they should only be risking up to £100.
• Limited liability partnership (LLP). All of the partners have limited liability. Each partner is only risking the amount of money they have actually invested in the partnership.

If you want more detail on how each type works and the red flags to watch for, see what is a partnership.

Why you need a partnership agreement

There is one thing you need to know before going into any partnership. Unless you have a partnership agreement in place, all of the debts, profits and liabilities of the business are shared equally between the partners. That is the default position, and it applies whether or not you intended it.

Equal sharing may not be suitable. Take the common situation where one partner has invested much more money than the others. Without an agreement, that partner still receives the same share of the profits as everyone else and carries the same share of the liabilities.

If you want different rights, for example a larger share of the profits for the partner who put more in, you will need a partnership agreement drafted to say so. In my experience this is the single most important step for anyone starting a partnership, and it is far easier to agree the terms at the beginning than after a disagreement.

Limited company: separate legal entity

The third business structure is the limited liability company, also known as the Ltd. Limited companies in the UK are registered at Companies House for a fee.

The key feature of a limited company is that it is a separate legal entity. When we say separate legal entity, we mean that the company registered at Companies House is recognised under the law as a separate legal person. As a legal person, the company can enter into its own contracts, take on its own debt and it has to pay its own taxes.

Because the Ltd is a separate legal person, it is responsible for its own debts. That is why you, as a director or shareholder, should not be personally liable for the company's debts. Compare that with the sole trader and the general partner, both of whom put their personal assets on the line.

Ltds are especially suitable for people who are ambitious, who want to grow a substantial business and who may even want to sell it to someone else in the future. They also suit people who are planning to do this alone, at least at the beginning, because you can incorporate the company and have full ownership of it from day one.

Which business structure is best for you?

Putting the three side by side:

• Sole trader. No registration, no fees, no forms. You pay personal income tax and you are personally liable for the debts of the business.
• Partnership. Two or more people pooling money and skills. Liability depends on the type: unlimited in a general partnership, limited for some partners in a limited partnership, limited for all partners in an LLP. Profits and debts are shared equally unless a partnership agreement says otherwise.
• Limited company. Registered at Companies House, a separate legal person that enters its own contracts, takes on its own debt and pays its own tax. Directors and shareholders should not be personally liable for its debts. Suited to businesses that plan to grow or be sold.

If you are a sole trader thinking of switching, the step-by-step process is covered in sole trader to limited company.

Next steps

Decide how much personal risk you are prepared to carry, whether you are going into business with other people, and how far you want the business to grow. If the answer points to a partnership, have a partnership agreement drafted before you start trading. If it points to a limited company, incorporate at Companies House and take advice on your duties as a director. A corporate solicitor can help you choose the right structure for your circumstances.