Ensuring your business is the right type of corporate entity is of the utmost importance – but which business vehicle is right for you?
The answer to this question depends on the nature of your business. In this article, we explain some of the basics about the most commonly used business structures, which are:
- Limited Liability Partnerships (“LLP”)
- Limited companies
A partnership is one of the oldest forms of business arrangement and predates the development of company law. A partnership is very quick and simple to set up although it does not have a separate legal personality from its partners. This means it cannot enter contracts or own property in its own name. Subject to any agreement to the contrary, all the partners are responsible for managing a partnership and decisions are to be made by a simple majority.
How do you set up a partnership?
A partnership is formed when two or more people (known as ‘partners’) agree to join together in a business venture with a view to making a make a profit.
There are very few legal formalities in forming or running a partnership as the agreement to form a partnership can be written, verbal or even implied by conduct. Whilst there is no requirement for a written partnership agreement, it is almost always advisable to have one to regulate the relationship between the partners, the operation of the partnership and the application of standard terms implied by law.
Pros and cons of partnerships
The main drawback of a partnership as a business vehicle is that its partners have unlimited personal liability for the partnership’s debts. This puts the partners at risk of losing their personal possessions and bankruptcy if the partners are unable to meet the debts of the business. Additionally, as partnerships do not have a distinct legal personality separate from the partners, they cannot enter contracts, own property, grant security or sue (or be sued) in their own name. This can also make it more difficult for partnerships to raise finance.
There are however some advantages, including:
- Lack of formality – There are no registration requirements;
- Privacy – Partnerships can maintain a level of commercial secrecy an LLP and limited companies cannot, in that they do not have to file accounts and other documents at Companies House;
- Tax – The profit generated by a partnership is distributed to the partners who pay ordinary income tax on the distributions they receive. The partners may also be able to claim tax reliefs where there are start-up losses in the partnership;
- Flexibility – It does not have prescribed director and member roles in the way that limited companies do, which can allow greater degree of flexibility with management and operations.
Limited Liability Partnerships
A limited liability partnership (abbreviated to LLP) occupies the middle ground between a partnership and a limited company.
An LLP is similar to a partnership in terms of taxation (it does not pay tax itself and the partners are taxed individually on their share of the LLP’s profits) and the LLP partners (or ‘members’) all generally take part in its management. They are otherwise more akin to private companies, including (unlike partnerships) in that they have their own existence separate from their members, and the members of an LLP have full limited liability.
How do you set up an LLP?
An LLP is formed by preparing and lodging a form ‘LL IN01’ and certain other documents at Companies House. The LLP will come into being upon Companies House issuing a certificate of incorporation.
Pros and cons of LLPs
The key benefits of an LLP compared with an ordinary partnership are limited liability and an LLP has a legal personality separate from its partners. This means it can enter contracts, own property, grant security and sue (or be sued) in its own name. The benefit for each partner is that that their liability is not joint and several with the other partners in the way it would be in an unlimited partnership. An LLP also benefits from the greater flexibility of partnerships in terms of management and operations compared with limited companies.
One of the disadvantages of an LLP is that it must file annual accounts and certain other documents at Companies House, which are published on the public register of companies and available for anyone to view. Additionally, the mechanics of transferring an interest in an LLP is typically more complicated than transferring shares in a limited company.
A company is a distinct legal entity separate from its members and directors. As such, similar to an LLP but unlike partnerships, companies can enter contracts, own property, grant security or sue (or be sued) in their own name.
A company is owned by its members and managed by its directors. The directors have a broad range of powers to represent and bind their companies. In doing so, they owe a number of duties to the company, including to act within their powers, to avoid conflicts of interest, to promote the success of the company and to exercise reasonable skill, care and diligence. However, certain decisions of a company must be approved by an ordinary or special resolution of its members. This division of powers between directors and shareholders set companies apart from LLPs and partnerships.
Companies need to file accounts and a confirmation statement at Companies House on an annual basis. The level of detail required in the annual accounts depends on factors including the level of turnover and number of employees, and whether the company is a private or public limited company.
There are three major types of company in English law:
- Private Company Limited by Shares – This is the most common structure used by most small to medium-sized businesses, in which the members own shares in the company and the day to day management is generally the responsibility of the directors. The members and directors of the company may be the same people but they do not need to be. (In smaller companies, they tend to be the same but less so for larger businesses or where the shareholders are pure investors). These companies have the suffix ‘Ltd’ or ‘Limited’ at the end of their name.
- Private Company Limited by Guarantee – The key difference between a private company limited by shares and a private company limited by guarantee is that there are no shares in the latter. Instead, the members of private companies limited by guarantee undertake to contribute a specified amount (commonly, £1) if the company is wound up while they are a member (or one year after they cease to be a member) in certain circumstances. As there are no shares, the members do not receive any dividends or other financial benefit. Accordingly, this type of company is often used by ‘not-for-profit’ companies, charities, members clubs, right-to-manage (RTM) companies and share of freehold companies.
- Public Limited Company (PLC) – A company that wishes to offer issuing shares to the public or to have its shares or other securities admitted to trading on the Stock Exchange must be a public limited company. Unlike private companies, they are required to have an issued share capital with a nominal value of at least £50,000. They are also subject to various other additional rules and requirements, including the need to hold an annual general meeting (AGM), to have a company secretary, to appoint an auditor (irrespective of annual turnover) and concerning share buy-backs and transactions with directors.
Like LLPs, the main advantage of companies is they have a distinct legal personality from their members and limited liability. This offers the directors and members of a company protection against personal liability, except in very limited circumstances where they have acted fraudulently or dishonestly. As companies can issue shares, enter contracts, own property, grant security and sue (or be sued) in their own name, it is also usually easier for them to raise both debt and equity finance compared with partnerships and LLPs. It is also normally more straightforward to transfer shares in a company than an interest in an LLP.
Whilst it is true there is an increased level of formality in setting up a company compared to a partnership, the process has become much easier and quicker, and it is possible to now incorporate a company within 24 hours.
Another perceived drawback of companies compared to partnerships is there is less corporate privacy. Companies must file annual accounts and confirmation statements, detailing their finances and shareholders, and publish details of their persons with significant control, all which information is then available to the public. In addition and unlike an LLP, a company pays corporation tax on its income and, when Its profits are distributed to shareholders as a dividend, the shareholders are liable for personal income tax on the dividend.
Which one is right for my business?
What is the right type of structure for your business will depend on a variety of factors. These factors are likely to include taxation treatment, market sector, management and ownership structure, whether your business will need to raise debt or equity finance privacy and risks of personal liability.
This article is provided for general information only and is not intended to be nor should it be relied upon as legal advice in relation to any particular matter. If you require specific legal advice on any issue detailed above or otherwise, we at Burlingtons Legal LLP will be able to assist. Please contact us on +44 (0)20 7529 5420 if you wish to discuss further.