It is important to select the right corporate structure for you and your business. This article outlines the main types of corporate structures and the pros and cons of different corporate structures to help you choose the best fit for your business.
Each business structure will have a different tax position and advice should be sought on that separately from legal advice.
What are the different types of corporate structures?
- Sole Traders
- Limited companies
- Limited by shares
- Limited by guarantee
- Partnerships
- General Partnerships
- Limited Partnerships
- Limited Liability Partnerships
What is a sole trader and what are the pros and cons?
A sole trader is a self-employed individual that personally owns the entire business and handles its day-to-day operation. This is the most simple type of business structure and so can be attractive for simplicity and control reasons.
Pros
- Minimum legal formalities to start trading
- Sole traders have full control of the business and any decisions that need to be made
- Sole traders can employ staff
- All assets will be personally owned by the sole trader
- No requirement to file any documents (such as annual accounts) at Companies House so there is a lighter administrative burden (and no publicly disclosed financial information)
- Fewer regulatory requirements
- A sole trader business can be changed into a company limited by shares
Cons
- Personal liability. Sole traders are, without limit, personally liable for the debts and liabilities of the business as well as the management and legal compliance of the business
- There can only be a single owner and operator of the business
- It may be harder to gain access to financing in comparison to limited companies
What is a company limited by shares and what are the pros and cons?
A private company limited by shares is probably the most common business entity. A private company limited by shares is a separate corporate entity. This type of company is made up of an issued share capital which is owned by at least one individual or entity known as a shareholder. Shareholders collectively own the company. Each company will also have a board of directors who are responsible for the day to day running of the business.
The company will also have articles of association which set out rules around how the company will be run.
Pros
- Separate legal entity. This enables the company to enter contracts and own assets in its own name
- Limited Liability. Shareholders will only be held liable for an amount up to the value that they have agreed to pay for the shares they each hold. This is one of the most significant advantages of a private limited company
- Flexibility. The articles of association can be amended to suit the needs of the company
- Only one shareholder and director is required to set up a company limited by shares
- Shareholders can also be directors if they wish to have a more active involvement in the day to day running of the company
- Offers some name protection as registered at Companies House
- Gaining access to financing can be carried out by issuing shares to investors. Private limited companies are usually more attractive to investors and lenders
Cons
- Greater administrative burden. You are required to file at Companies House records of, for example:
- persons of significant control
- directors
- shareholders
- registered office address
- certain company activities (such as change of name, certain shareholder resolutions)
- financial records and accounts.
- Records held at Companies House are open for public inspection (including constitutional articles of association setting out certain organisational structure and arrangements).
- More expensive to set up and there are ongoing costs (such as filing and accounts preparation)
- Risk of conflict. Where there is more than one director or shareholder, the business relationship can deteriorate. However, to try to cater for this, shareholders can enter into a shareholders’ agreement which sets out what would happen if the relation did not go according to plan.
- The directors of a private limited company have fiduciary and statutory duties and responsibilities to comply with such as acting in the best interests of the company and avoiding conflicts of interests.
What is a company limited by guarantee and what are the pros and cons?
Unlike a private company limited by shares, a company limited by guarantee does not have a share capital or shareholders, but rather members that control it. The members’ liability is limited to the amount each member has agreed to contribute up to in the statement of guarantee.
We most often see this type of company in the context of property management companies (and they are often used for charities, clubs and societies). In the context of property management, this type of company enables a smoother process when the developer is ready to handover ownership of the company to the residents at the development as, subject to the provisions of the articles of association, the developer can simply resign its membership and the residents can be admitted as members. There is no requirement to transfer the membership like there would be if the company was limited by shares.
Pros
- Separate legal entity. This enables the company to enter into contracts and own assets
- Limited liability. The members will only be liable for debts up to the amount that they have undertaken to contribute to the company.
Cons
- Cost involved to set the company up and ongoing costs and filing requirements
- The company cannot issue shares to raise capital
- No dividends. Members do not receive dividends from the profits of the company
How do partnerships work and what are the main types of partnerships?
Partnerships are formed when two or more individuals convene to own and operate a business with a view to profit. Partnerships can be established for a specific project or for an indefinite period of time. The benefit of a partnership is that different partners can bring different expertise to the business.
There are three main types of partnerships available:
- General Partnerships
- Limited Partnerships
- Limited Liability Partnerships
The key differences between these partnership types revolve around liability and management. General partnerships offer no liability protection, limited partnerships offer limited liability for some partners and limited liability partnerships provide limited liability for all partners. The choice of structure depends on the specific needs and preferences of the business owners.
What are the pros and cons of a General Partnership (GP)?
Whilst partnerships are, by default, governed by the Partnership Act 1890 (and can be formed verbally or in writing), it is advisable for partners to enter into a formal partnership agreement. This allows partners to agree and document key terms on which the partnership will run (such as a minimum notice period, profit sharing arrangements and partner responsibilities). This would be a private document between the partners.
Pros
- There is no requirement to register a GP at Companies House or to file any documentation, such as annual reports
- Entering a GP is quick and cheap. It also easy to dissolve so it would be better suited to short term partnerships
- GPs can be transferred into limited liability partnerships at any stage
- Any partnership agreement is a private document which is not publicly available
Cons
- Partners are personally liable for the debts of the business and this liability is not capped so personal assets are vulnerable
- The default position is that all partners have joint and several liability so, if one partner accrues any debt, the other partners can be expected to pay it
- A GP, particularly without a partnership agreement in place, can be vulnerable to conflict
- A GP is not a separate legal entity which means it cannot enter into contracts or employee staff in its own name
What are the pros and cons of a Limited Partnership (LP)?
LPs are largely similar to GPs. The main distinction is that there are two types of partners: general partners and limited partners. General partners are responsible for the day to day running of the business. Limited partners can invest in the business without any active involvement, they are also referred to as ‘silent partners’.
Limited partnerships are, by default, governed by the Limited Partnerships Act 1907. As with general partnerships, it is advisable for partners to enter into a formal partnership agreement (which would be a private document). This allows partners to agree and document key terms on which the partnership will run.
Pros
- Liability for limited partners is limited to the extent that each limited partner has invested in the partnership
- Partners can be separate legal entities (such as limited companies as above) or individuals
- Any LP agreement is a private document which is not publicly available
- Offers some name protection as registered at Companies House
Cons
- Liability for general partners is unlimited, so their personal assets could be at risk
- The role of a limited partner in relation to the running of the business is limited
- English LPs are not separate legal entities which means that they cannot enter into contracts or employee staff in their own name
- LPs need to be registered at Companies House, although there is no requirement to file annual accounts
What are the pros and cons of a Limited Liability Partnership (LLP)?
A limited liability partnership is established under the Limited Liability Partnerships Act 2000. As with the other types of partnership we have referred to, it is advisable for a formal LLP agreement to be entered into to govern the relationship between the partners.
This type of structure is often found in professional services firms such as solicitors and accountants.
Pros
- Limited liability. All members will only be liable for debts up to the amount that they have undertaken to contribute to the partnership (although partners can be personally responsible for their own professional negligence or misconduct)
- Flexibility. Members can agree on key terms such as distribution of profits and day to day responsibilities
- Members can be individuals or corporate entities
- Unlike LPs and GPs, LLPs are separate legal entities (keeping them entirely separate from its members and allowing them to enter into contracts in their own name and employee staff directly)
- Offers some name protection as registered at Companies House
- Any LLP agreement is a private document which is not publicly available
Cons
- Requirement to register the LLP at Companies House and file annual financial accounts and other documentation
- Companies House records are available for public inspection
How Moore Barlow can help
If this is something that you would like to discuss further, a member of our Corporate Law team would be happy to help.
At Moore Barlow, we provide corporate legal advice that is built around you and your business. We put your needs first and give you a succinct explanation of complex legal matters so that you can act quickly and confidently to any opportunities that may arise.
