Setting up your own business a guide to legal structures

Transcription

1 Briefing paper: Setting up your own business a guide to legal structures Written by John Stephens Produced by

2 Important note: this guide is intended as an overview, and not as legal advice. You should always seek professional legal advice about the appropriate legal structure for your own particular circumstances. Why is it important to consider legal structure when setting up a business? 1. Compliance staying within the law Anyone who is selling a product or a service has legal responsibilities. These include: Keeping paperwork up to date, including records of income and expenditure. Paying taxes that are owed as a result of the business activity. Understanding when you can, and cannot, take profits out of the business, and following the correct procedures when you do. Fulfilling certain liabilities if the business becomes insolvent, or ceases trading because it is unsustainable. Different legal structures are regulated by different regulatory bodies. It is important that you know who regulates the legal structure your business adopts, and what paperwork has to be completed and when. 2. Scaling up growing your business As your business is grows it is likely that more people will be involved in ownership and decision making. For example, you may wish to exchange a percentage of the ownership (or equity) for a cash investment, borrow from a bank, or apply for some grant funding from a local authority or the Government. Whether these opportunities are feasible for your business will depend to a certain extent on the legal structure you adopt. 3. Your mission If your business has a social impact or mission, as well as trading or selling services, then it can be described as a social enterprise. The term 'social enterprise' itself has no legal status, an organisation is a social enterprise not because of its legal status but because of its activities. A social enterprise can adopt a variety of different legal structures, however there are some legal structures which are specifically helpful to social enterprises (see below for more information).

3 Can I set up a business without a formal legal structure? An individual working outside of any formal legal structure is described as a sole trader, or self-employed. They are alone responsible for their business, but can employ people, and trade under a business name. Sole traders must register with HM Revenue & Customs (HMRC), fill in an annual self-assessment form, and pay income tax and National Insurance (NI). A sole trader can keep their business' profits after paying tax on them. Sole traders are responsible for all of their business' debts, losses and liabilities. An organisation of more than one person operating without a formal legal structure, (for example a membership group, community choir or sports club) is known as an unincorporated association. Individuals within an unincorporated association can be held responsible for its liabilities. Usually there will be a written constitution governing the affairs of the association. The common legal structures for businesses in the UK: Limited companies: 1. A company limited by shares is an organisation completely separate from your personal finances. A limited company has shareholders who own the company, and directors who run the company. Directors can be shareholders, but don't have to be. Profits are owned by the company and can be distributed to shareholders (after corporation tax has been paid) in the form of dividends. Shareholders and directors are not personally responsible for debts the business can't pay, as long as they haven't been negligent or broken the law. limited by shares are the most common legal form for private sector organisations in the UK. 2. A company limited by guarantee is similar, but directors liability is limited by a guarantee, often a very small amount. This structure is very widely adopted by charities and social enterprises. Although profits can be distributed, usually the company's constitution will be written so that all proceeds are reinvested in the company. Community Interest or CICs were introduced recently to facilitate community based social enterprises seeking to be more entrepreneurial than traditional charities. CICs are normally limited companies that apply for additional CIC status. To qualify as a CIC the company must satisfy a 'community interest' test. The assets of a CIC are locked so they can only be used for its social objectives, and any profits are

4 reinvested in the company. An Industrial & Provident Society (IPS) is a legal structure optimised for organisations that are owned and led collaboratively by their members. These include those that exist for the benefit of their members like for example worker's co-operatives, allotment societies and working-men's clubs, and those that benefit the community, such as housing associations. In a business partnership, partners share responsibility for the business and like sole traders are individually responsible for paying income tax. Partners share the business profits and are jointly responsible for all of their business' debts and losses. A formal partnership agreement is normally put in place to regulate the affairs of the partnership. A limited liability partnership (LLP) is a special type of partnership favoured by professionals like lawyers and accountants where partners' responsibility for business debts is more limited. (Please note: partnership law in Scotland differs from that described above). UK Charitable Status Charitable status is not a legal form or structure, but is, as its name implies, a status which is awarded by the Charity Commission. To apply for charitable status organisations will normally be either a company limited by guarantee, or an unincorporated association (an IPS can also have a type of charitable status, achieved through a separate legal process). To qualify for charitable status the organisation must demonstrate that its activities are of 'public benefit'. Registered charities are required to have a board of trustees. Trustees are not allowed to receive remuneration from the company. The additional compliance requirements associated with charitable status can be seen as a disadvantage. However there are also significant advantages. For example, charities benefit from significant tax exemptions and reliefs, and the kudos and credibility associated with charitable status can significantly strengthen the company image or brand. A Charitable Incorporated Organisation (CIO) is a new legal form available since January CIOs are designed for smaller organisations who wish to have the advantages of charitable status without the dual regulatory burden imposed by House and the Charities Commission. The target market for CIOs is new and existing charities with incomes between 10,000 and 500,000. Useful links

5 Appendix: Legal Structures Summary Name Pros Cons Regulato Sole Trader Simple to set up and administer The individual has unlimited personal liability for all business debts and other claims HMRC (throug self-assessm Unincorporated Association - Simple to set up and administer - Can hold property - Can apply for charitable status - Can only make agreements or contracts through individual members - Individual members have unlimited personal liability for all debts and other claims MRC (if tradin Company Limited by Shares - Widely understood status, the most common legal structure for business organisations in the UK - No personal liability for debts (unless there is negligence, fraud or other criminal activity) - Easy to grow the company, can be attractive to investors - Invoicing more straightforward than for sole-trader (eg with local authorities) - Can have a single member - Higher administrative burden and costs than sole trader - Cannot apply for charitable status - Unlikely to be eligible for philanthropic grants or public funding House and H Company Limited by Guarantee - Most common legal structure in the social sector (eg for social enterprises and charities) - Limited personal liability for debts (unless there is negligence, fraud or other criminal activity) - Can apply for charitable status, with consequent tax and other advantages - Can own property and hold contracts - Can have a single member - Higher administrative burden and costs than unincorporated association - Not attractive to investors as assets and profits are normally locked by the company's constitution House and H

6 Community Interest Company (CIC) - Clearly identifies and brands your organisation as a social enterprise - More freedom for entrepreneurial activity than charitable status allows - Supports collaborative/democratic leadership models - Assets are protected by an asset lock - Only relevant to social enterprises - Must satisfy a community interest test - Have to be compliant with two regulatory bodies - Cannot apply for charitable status (intended to be an alternative) House and CI Regulator an HMRC Charitable Incorporated Organisation (CIO) - A new form of limited liability company that has charitable status, targeted at smaller organisations - Lower administrative and regulatory burden - May not suitable for more entrepreneurial organisations - Is a relatively new legal structure, and hence is untested UK Charity Commission HMRC Industrial & Provident Society (IPS) - Structure is optimised for worker and/or community cooperatives - Can own property and hold contracts - Assets are locked - Allows for co-operative management models and democratic ownership - Allows for more entrepreneurial activity compared with charitable status - Must have at least three members - Less well known legal structure (eg for branding purposes) - Less suitable for traditional hierarchical management structures - Less likely to be eligible for philanthropic grants or public funding, unless specifically established for the Benefit of the Community Financial Services Authority (FS and HMRC Partnership - Relatively easy to set up and administer - Partners can share profits directly - Tax is paid through self-assessment, as for sole-traders Partners have unlimited personal liability for all business debts and other claims HMRC Limited Liability Partnership (LLP) - Most common legal structure for groups of professionals such as architects, lawyers and accountants More appropriate for professional service providers, less so for businesses selling products House and H