Small Business Startup Guide
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Legal Structures for Companies
[Note: To purchase or to enquire about forming a company, please see our sister site, Starting My Business, for their range of company formation packages for start ups.]
Sole Proprietorships This is the most simple of all legal mechanisms and may provide the ideal conduit for the small businessman. Certainly, it is not encumbered with the legalistic formalities of other business organizations and the owner does have complete control to hire, fire, enter into agreements or even cease to trade however and whenever he so pleases.
Unfortunately, this complete control and simplicity is tempered by the simple fact that there is no legal distinction between the actual business and the owner. In other words, any liabilities, debts or charges for which the business is liable, you are also personally liable. Application
Very commonly used and may or may not be more tax and cost efficient than a simple limited liability structure, depending on applicable double taxation rules and individual/corporate tax rates.
Advantages
- Owner has complete control over all business affairs
- Simple to administer and operate
- Long-established business mechanism
Disadvantages
- No distinction between personal and business entities and therefore, no protection for one's own personal assets.
- There is no tax distinction between personal and business income, often leading to an inefficient use of potential tax savings.
- A Sole Proprietor is liable for the actions of his employees.
- Action taken by creditors is often quicker against an individual than against a corporate entity.
- The physical movement of the entity will always correlate with the physical movement of the owner. Generally, most tax benefits are, particularly where 'foreign' transactions are involved accrued from distinguishing between a person and his business.
- Save where the individual's reputation is established such entities are not considered as 'reputable' despite the increased exposure.
Partnerships
By definition a Partnership is the coming together of two, or more individuals for their common good. Like the 'Sole Proprietorship', the Partnership is almost totally exposed to third party actions. Legally, a Partnership can often be formed with no written agreement, however, one would be ill advised not to set-out the rights and obligations of the partners.
If no such agreement is in existence, standard legal interpretations, for the appropriate jurisdiction, will generally be imposed unless there is clear evidence that the partners are subject to their own set of criteria. One point that should always be born in mind is that in the case of 'economic' difficulties each partner will be liable not only for his shareholding but for all partnership debts. Application
Very popular, especially amongst small business enterprises. In certain jurisdictions, in particular the United Kingdom, there can be some tax benefits. Generally, firms of lawyers and accountants are forced to adhere to this legal structure as a form of protection for their clients.
Advantages
- It brings together two or more people who have a personal interest in the welfare of the business enterprise.
- A partnership is generally seen as more professional than a sole proprietorship.
Disadvantages
- There is always the potential of partnership disagreements.
- Each partners personal assets will often be subject to creditor action, no matter his personal obligations/liabilities under the 'partnership agreement'.
- Generally, the burden of being a partner falls unfairly on the wealthier individual. In other words, if X and Y become partners but X has twice the assets of Y, then accepting an equal partnership - X and Y will share equally in the profits but X has twice as much to lose should the partnership fail.
- The cost of drafting a 'partnership agreement' can be prohibitive.
- As with sole proprietorships, the problem with partnerships is that it is very difficult, if not impossible, to separate partnership business activities from the individual partners.
Limited Partnerships A Limited Partnership is, if you like, the 'Missing Link' between a general partnership and a limited liability entity. Until recently such legal entities did not exist in the United Kingdom but now do so in a hybrid form since the introduction of the Limited Liability Partnership Act of 2000 save that such UK LLP's have a lot in common with limited campaniles particularly in respect to being a separate legal entity.
General Limited Partnership Rules: Unlike an ordinary partnership, there are two distinct types of partner, the General Partner and the Limited Partner. The former occupies a position identical to that of a partner in an ordinary partnership and ' therefore, will play an active part in the day-to-day management and control of the business. In particular, and as with an ordinary partnership, the entire general partners assets could be subject to future creditor action.
However, the limited partner is in a far more enviable position; his liabilities are strictly limited to the extent of his investment and/or as outlined in the 'Limited Partnership Agreement'. In other words, an investor who plays no active part in the day-to-day operation of the business is afforded the benefit of limited risk very similar to that of a person wishing to purchase the shares of a particular company on the stock exchange. Obviously, the situation is very favorable for the limited partner provided he takes the normal precautions of carefully reading the terms and provisions of the Agreement.
For the active partner the situation is not so good since if the non-active partners have limited liability, the implication is that the proportion that they would otherwise have been liable to, if the business was a mere partnership, would be passed on to the General Partner(s) Application
Very popular in the United States and Continental Europe but rarely used in the United Kingdom or Ireland. Often has no, or at least minimal, capitalization requirements. In certain circumstances they can be more tax efficient than a company.
Advantages
- General partners have the same benefits listed for an ordinary partnership.
- The limited partners are only liable in proportion to their initial investment.
- Tax transparency and the potential to Use the tax treaty of the country in which the limited partnership is registered can provide offshore benefits.
- Can provide benefits where investment vehicles, such as investment funds, are involved.
Disadvantages
- The general partner may have even greater personal exposure to third party actions than with a limited company .
- Each partners personal assets will often be subject to creditor action, no matter his personal obligations/liabilities under the 'partnership agreement'.
- Not available in the United Kingdom, Ireland and most other traditional common law jurisdictions. Residents of these countries could have difficulty in obtaining professional advice. The limited partnership agreement may have to be specially drafted by a lawyer and may cost more than an equivalent fully limited liability entity. - Where this type of business entity is suggested it is always recommended that professional advice is sought to ensure that a limited partnership is the most appropriate and beneficial mechanism.
Limited Liability Companies
The primary advantage of these entities is that they are all based on the simple principle that the liability of the shareholders and officers is strictly limited to their direct investment in the company. Generally, the only exceptions are when some kind of fraudulent or grossly reckless act or omission has occurred involving company officers. It is important to note that the 'innocent' shareholder without any involvement in the malfeasance will not lose the benefit of limited liability.
Basic Types of Limited Liability Companies
In simple terms, although there are many variations on the theme, most companies can be divided into profit and nonprofit making. In respect to the latter, these are generally of a charitable or organizational nature, complex and very rarely used by private individuals. Nevertheless, it should be noted that they fully enjoy the limited liability concept, subject to the same, or even more stringent, fiduciary duties on company officers.
In respect to profit making limited liability companies these represent the most popular business structure in the United Kingdom and in most other developed countries.
In the UK there are two main subdivisions for profit making companies: private limited liability or 'close stock' companies and public liability or 'open stock' companies. In very few cases will the average business start up company user have any connection with 'open stock' or public limited companies companies but technically such companies do not have to officially list themselves on a stock market.
Private Limited Liability Company - In Great Britain there are two registries the one for English and Welsh companies based in Cardiff and the one for Scottish companies based in Edinburgh. In both cases the Duty is only £20.00 but a company registration agent is required to submit company memorandum and articles of association. General retail prices for limited companies with ordinary objects and shares vary from around £55 to £300.00.
Public Limited Liability Company - The basic criteria for PLC's is the same as for private limited companies save that a minimum of £50,000 worth of shares must not only be issued but physically paid up within 5 years. In addition, the memorandum and articles are often substantially more complicated often having a number of share categories with preferences as to dividends, voting rights etc. The records of PLC's are also subject to a higher level of scrutiny particularly regarding accounts. General retail prices for public limited companies with ordinary objects and shares vary from around £150 to £300.00 but can cost thousands if specialist drafting is required.
Application
By far the most popular business structure in the UK with over 4.5 million private limited companies having been registered with Companies House in Cardiff and Edinburgh.
Advantages
- Liability is, in the vast majority of cases, strictly limited to the investments made by the shareholders.
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Company Officers are not personally liable for their actions unless, in most instances, there is a clear and serious breach of their fiduciary duty.
- Ironically, despite the limited liability, such entities often benefit from 'greater prestige' than their sole proprietorship or partnership counterparts. The reason is probably because such an enterprise normally requires more planning and thus is deemed more credible.
- They often benefit from significant tax advantages especially where offshore companies are employed. In fact, many countries around the world give exclusive tax incentives to this type of entity.
- In many cases, companies, both onshore and offshore, can be structured to provide confidentiality
The rights of shareholders are normally clearly defined and protected.
Disadvantages
- In larger companies shareholders often lose direct control over their investment.
- Limited liability companies generally require the appointment of accountants, auditors and professional company secretaries. This means that such a structure is often more expensive to maintain than simple sole proprietorships or partnerships.
- In many civil law countries the 'benefits' of' limited liability are often denied because of high initial capitalization requirements.
- Certain professional bodies, especially those representing the legal and medical fields, do not allow members to register a limited liability company. In many instances, this denial has resulted in very high indemnity insurance |
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