What Type of Business Can You Set Up in the UK? A Guide for First-Time Founders

Sole trader? Limited company? Partnership? And what is the difference between a company limited by shares and one limited by guarantee?

Your choice affects who owns the business, how you pay tax, what paperwork you need to complete and how much personal responsibility you may have for its debts. The good news is that you do not need to become an expert in company law. You just need to understand the main options and how they fit your plans.

First, a business is not always a company

People often use business and company to mean the same thing. Legally, though, they are different. You can run a business as a sole trader or through an ordinary partnership without incorporating a company. A limited company, by contrast, is registered with Companies House and exists as a separate legal entity.

If you are starting a business in the UK, understanding that distinction will help you make sense of the options below. [1]

1. Sole trader: running a business in your own name

Being a sole trader is a straightforward way to start working for yourself. You run the business as an individual, make the decisions and keep the profits after tax. You can trade under your own name or choose a separate business name.

There is no company to incorporate at Companies House. You will, however, need to register as a sole trader for Self Assessment with HMRC if you earn more than £1,000 from self-employment in a tax year, or if another registration requirement applies.

The main thing to understand is personal liability. Because you and the business are not separate legal entities, you are personally responsible for its debts. That is worth considering if you plan to borrow money, take on substantial contracts or make large purchases.

Sole trader status can suit someone starting a freelance service or testing a business idea independently. You can also move to a limited company later if your circumstances change. [2]

2. Private limited company by shares: a separate business with owners

When someone talks about setting up a limited company in the UK, this is usually the type they have in mind.

A private company limited by shares is a legal entity in its own right. It can enter into contracts, own assets and incur debts separately from its shareholders.

The shareholders own the company, while its directors are responsible for running it. You can be the sole shareholder and sole director, so there is no need to find a business partner just to form a company.

Shares determine ownership. If you own all the shares, you own the whole company. With a co-founder, you can allocate shares to reflect your agreed ownership split.

Shareholders generally have limited liability, meaning their responsibility for company debts is limited to any amount unpaid on their shares. That protection has limits, though. Directors can incur personal liability in certain circumstances, and personal guarantees create separate obligations.

This structure can suit businesses that want a distinct legal identity, expect to bring in shareholders or hope to grow beyond their original founder. It comes with ongoing responsibilities too: directors must ensure that the company keeps proper records and submits accounts, confirmation statements and other required filings. [3]

3. Private limited company by guarantee: members rather than shareholders

A company limited by guarantee is also a separate legal entity, but it has guarantors instead of shareholders.

Each guarantor agrees to contribute a specified amount if the company is wound up and cannot pay its debts. That amount can be small, such as £1.

Companies limited by guarantee are commonly used by clubs, membership organisations and community groups that do not intend to distribute profits to owners.

Imagine local residents establishing a community arts organisation. They want a formal structure through which they can enter into agreements and manage funds, but they do not want the organisation owned through shares. A company limited by guarantee may be worth exploring.

It is not automatically a charity, although some charities use this structure. [4]

4. Ordinary partnership: starting a business with other people

An ordinary business partnership allows two or more people to run a business together and share its profits. You and a colleague might choose this route for a small consultancy, for example.

Unlike a limited company, an ordinary partnership in England and Wales does not create a separate legal entity from its partners. Partners can be personally responsible for business debts. In Scotland, a partnership has separate legal personality.

Partners generally pay tax on their individual shares of the profits, and the partnership has tax reporting requirements of its own.

Before starting, put the important arrangements in writing. Who makes decisions? How are profits divided? What happens if one person wants to leave? Those conversations become considerably more useful when you disagree about something six months later. [5, 6]

5. Limited liability partnership: partnership-style working with limited liability

A limited liability partnership, or LLP, combines features of a partnership and a limited company. It has a separate legal identity and is registered with Companies House. Its owners are called members rather than shareholders.

Members generally benefit from limited liability, while profits are usually taxed at member level rather than in the same way as a conventional limited company's profits.

LLPs can suit businesses where several professionals want to work together while retaining a partnership-style arrangement. You may come across them in legal, accounting and consultancy businesses.

You need at least two designated members, who take responsibility for certain administrative and filing duties. An LLP must also submit accounts and a confirmation statement to Companies House.

An LLP is not simply a limited company with a different name. Its ownership and tax arrangements work differently, so it is worth understanding those differences before choosing it. [7]

6. Community interest company: running a business for community benefit

What if the main purpose of your business is to benefit a community rather than maximise returns for its owners? A community interest company, or CIC, may be worth considering.

A CIC is a type of limited company created to pursue a community purpose. It can be limited by shares or by guarantee, depending on how it is intended to operate.

For example, you might establish a business providing employment opportunities to people facing barriers to work or run a local service that reinvests its surplus into the surrounding community.

CICs have additional requirements, including a community interest test and an asset lock. The asset lock helps ensure that the organisation's assets are used for its community purpose rather than simply distributed for private gain.

A CIC limited by shares can pay dividends in some circumstances, but restrictions apply. This is a distinct structure with a particular purpose, so understand the requirements before choosing it for a social enterprise. [8]

7. Public limited company: a structure for larger capital-raising plans

A public limited company, or PLC, is another type of company limited by shares. Unlike a private limited company, a PLC can offer shares to the public, subject to the applicable rules. That does not mean every PLC is listed on a stock exchange.

A PLC has additional formation and governance requirements, including minimum share capital requirements and at least two directors.

For someone launching a small business, a private limited company will generally be the more relevant structure to investigate first. A PLC is more likely to become a consideration where there are specific plans to raise capital from the public. [9]

How do you decide which structure fits your business?

There is no single answer for every founder.

Think about how you plan to operate. Will you work alone or with partners? Do you want others to own a share of the business? Will you need investment? Is your main aim to generate profits for owners or provide a community benefit?

Consider your responsibilities too. Personal liability, tax treatment, record keeping and reporting obligations differ between structures.

You do not need to predict what your business will look like in ten years. But it helps to choose a structure that suits what you are building now while keeping your longer-term plans in mind.

And if you are unsure, speak to an accountant or an appropriate legal adviser before registering. Getting clear on the basics at the beginning is easier than untangling an unsuitable arrangement later.

The business idea is yours. The structure is simply the framework that helps you turn it into something real.

Sources

[1] https://www.gov.uk/set-up-business

[2] https://www.gov.uk/become-sole-trader

[3] https://www.gov.uk/limited-company-formation

[4] https://www.gov.uk/limited-company-formation/guarantors

[5] https://www.gov.uk/set-up-business-partnership

[6] https://www.legislation.gov.uk/ukpga/Vict/53-54/39/section/4

[7] https://www.gov.uk/guidance/set-up-and-run-a-limited-liability-partnership-llp

[8] https://www.gov.uk/government/publications/community-interest-companies-how-to-form-a-cic/community-interest-companies-guidance-chapters

[9] https://www.smallbusinesscommissioner.gov.uk/help-and-guidance/all-advice/guide-to-types-of-businesses/