Tips to structuring your business

How your business is structured defines how your customers, suppliers and staff see you, how you are taxed and the extent of your liabilities. It is therefore important to get the structure right. The object of these tips is to help you make the right decisions.

Forming a limited company

Shareholders and directors are required to comply with the legal requirements of the Companies Act and related regulations. You should be aware of what that means. The regulations are generally a matter of common sense and are not unduly onerous, but if you feel uncomfortable about being a director of a company then you should read up or take advice on the subject.

Why form a limited company?

A limited company has a number of advantages

1. As the name suggests - Limited liability. You will not normally lose your shirt unless you have given personal undertakings to banks or other company lenders.
2. Dividing profits - By giving your spouse shares in the company you can distribute profits in a tax efficient manner, using up both partners nil and basic rate income tax band. However following a recent tax ruling, professional advice should be taken before allotting or transferring shares to a spouse.
3. New investment - Sometimes businesses seek equity capital to help fund expansion. By offering the investor shares in the company a definable stake in the future of the business. The investor may also qualify for tax relief on his investment.
4. Business building - The company structure allows businesses to build up reserves in a lower tax environment as company profits are generally taxed at a lower rate than unincorporated businesses. Companies seeking to impress their customers or suppliers may wish to convert some of their profits into shares thereby boosting their balance sheet.
5. Incentivising key staff - There are a variety of share option and incentive schemes to motivate staff. A note of caution - some businesses has jumped into these schemes, only to rue the day. Be clear about the objectives of any scheme and what could go wrong.
6. Selling the business - For tax reasons, from a seller's point of view the tax legislation normally favours selling shares rather than business assets. It is also a cleaner way of selling a business because the trade, assets and liabilities are sold as a package.

The disadvantages of forming a limited company are:

1. Cost - Companies are more costly to administer because of the cost of complying with regulations and this translates into higher accountants bills.
2. Directors' responsibilities - Ignorance of the law is no excuse.
3. Company records - Company accounts and details about the company, its directors and shareholders are on public view at Companies House.
4. Tax issues - Companies are liable to a lower rate of tax than individuals (particularly if you take into account national insurance contributions on salaries drawn). A company must keep at least part of its profit to benefit from the lower tax rates. If you do not intend to retain profits in the business then you should question whether it is right to form a company.
5. Selling the business - From a buyer's point of view the tax legislation often favours buying the business assets rather than the company's shares. When setting up a business and deciding whether you should form a company, care should be taken to ensure that any valuable assets are held in the right place.

Unincorporated businesses and partnerships

This is still the route that many businesses follow when setting up. Partnerships are becoming less popular - and with good reason. Do you really want to be personally responsible for the mistakes your partner has made. The answer for must of us is - not unless we have to. Despite this, partnerships are still popular with the professional businesses such as accountants, lawyers and architects. With the recent introduction of Limited Liability Partnerships (LLP's) this is likely to change in the future.

Why set up as an unincorporated business?

The advantages of an unincorporated business:

1. Tax and the early years - When starting a new business you may expect to incur a loss in the first year or two. You can claim tax relief for these losses, either against your other income in the same year or by carrying these losses back and setting the loss against your income in the three previous years. If you have been paying tax at 40% you could be entitled to a healthy refund.
2. Husband and wife partnerships - Profits can be split between the two spouses without the need for the non-working spouse to justify his/her position. This can save a substantial amount of tax.
3. Keeping it simple - There are no specific regulations as to how your business accounts should be prepared provided that they comply with what is termed "good accounting practice". This will help keeping your accounting bills lower.
4. Confidentiality - There is no public record of your business activities, which means that you have greater privacy.
5. Benefits in kind - Directors of limited companies are subject to a strict tax, and more recently national insurance, charge on any benefit drawn from a limited company. Owners or partners in unincorporated businesses are liable to tax under a more pragmatic system.
6. Selling your business - Buyers will love you because they are acquiring assets not shares.

The disadvantages of an unincorporated business:

1. No limited liability - In businesses where the risks are low, this may not be too much of a problem. A lot of businesses do have significant risks. These may or may not be covered by insurance.
2. Tax and business building - All business profits are liable to income tax at rates up to 40%. This will act as a disincentive to building up business reserves.
3. Customer perceptions - As illogical as it sounds, your customers are likely to take the view that you are less credible as an unincorporated business than if you formed a limited company. This stems from the fact that there are no publicly available records about unincorporated business and as a result credit agencies take a less favourable view of these businesses.

I hope that by reading through these issues you have gained a clearer insight as to what factor you should be addressing when deciding how to structure your business.

If you would like any further assistance in helping you to decide how to structure your business please contact us.