The question for you today is ‘Are you running your business in the right structure?’ The structure of your business can have a huge impact on a number of key issues. The tax you pay, whether your personal wealth is at risk, and even how saleable the business is when you are ready to exit, are all impacted by whether you are a sole trader, partnership or a company for example.
What is a business structure? Businesses can operate through variety of formats. Many small businesses often start as ‘sole traders’, one person working on their own. Sometimes two or more people may form a ‘partnership’ where they work together and share the work and the rewards between them.
It is usually quick and easy to set up in this way, but the problem with these simple structures is that there is no protection from financial risk. If the business fails, creditors (suppliers, HMRC, employees etc) can go after the business owner(s) to collect their debt, whether from personal savings or even the value in their home.
In addition, the tax regime for these structures is that profits are taxed in full, even if the sole trader or partners have not taken the money from the business. A bumper year could see high tax bills even if you leave the money on the business.
So what are the alternatives?
If you do want to operate as a partnership, you could form a limited liability partnership (LLP). Whilst the tax issues are the same (profits tax regardless of whether Partners take the money out), the personal wealth of the Partners is out of reach of any creditors of the business. Many professional firms that have Partners leaving and joining on a regular basis, prefer the LLP structure.
However, the vast majority of business now operate as limited companies. A company is a legal entity in its own right and separate from the individuals that own and run it.
A company has shareholders that own the business, and this can be one individual with 100% of the shares, or any number of individuals owning a slice of it, from a husband and wife business owned 50:50, to a company listed on the stick exchanged that could be owned by millions of shareholders. There can be different classes of shares with different rights and values, so that there is almost infinite flexibility with how a company is owned.
A company also has directors. They are the people that run the business on a day to day basis. Again, this could be one individual, or many doing different roles within the business. In small businesses the directors and shareholders may be the same people.
Being a limited company protects the owners from financial risk, as creditors can only look at company assets to get paid, and the personal wealth of shareholders and directors is protected.
A key aspect of a company structure is that the business is taxed on the profit it makes, but the directors and shareholders are taxed on the amount they withdraw as salary or dividends. This means that a business that retains profits for growth and investment will pay less tax than the partners of a partnership would pay based on the same results.
Another key aspect to consider is how a businesses may be sold in future. In simple terms, it is considerably easier to sell a company structure than it is to sell a sole trade or partnership business. This can be both the likelihood of finding a buyer at all, but also in the ease of sale and the tax that arises on the proceeds.
The final nuance to business structures is to consider having multiple companies in a group. Let’s say you have a business that is doing OK and has bought its business premises. If the business gets into difficulty and cannot continue, any equity in the building will be available to the creditors of the business when it closes. If however, that property were owned in a holding company sat on top of the trading company, creditors of the failed trading business could not get to the equity in the property owned by the top company.
There are of course many other aspects to the decision on what structure works best in any business, but in the majority of cases a limited company structure is likely to be best. If that business owns, or may in future own, property, valuable equipment, intellectual property, accumulated cash reserves etc, then a two tier company structure may provide even greater protection in the event of any future business difficulties.
Even if your business is already up and running, it may be that you should consider a change to the right new structure for you. Whilst that can be complicated, it can sometimes create opportunities to reduce tax bills, or extract money tax efficiently from the business.
So, are you running your business in the right structure?
If you have any questions about whether your business is structured in the right way, just give us a call.
01752 220979
For further details on business structures and managing risk, explore our other posts.
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