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Beyond the balance sheet

The different types of business structures for growth

Ercan Demiralay 31/3/2017 6 minute read

Ercan Demiralay on the need to review the structure of your business as your organisation moves into growth.

Growing a business can be time consuming, especially when you find yourself re-visiting the decisions you made during the start-up phase. Having proven your concept, established your operations and moved into the growth phase, it’s likely that you'll have to look again at the different types of business structures.

Why? During the start-up phase decision making can be difficult because it’s not always clear which path your business is going to take. That’s why so many entrepreneurs form their views and direction for the business based on their needs at that particular time.

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Perhaps you initially set up as sole trader for administrative and financial ease and you’re now looking at the option of a limited company or, maybe a partnership is preferable with less administrative duties. Whichever of the different business structures you decided upon in the early days, it's probable that what functioned well then may no longer work now that you’re growing.

Why change your legal structure and operational set up?

Whilst there are no set rules for which vehicle will work for each business, your aims and goals can provide an indication of which operational vehicle will most likely optimise growth. Bear in mind that as your business expands your aims are likely to change especially if you have a scalable business model.

It’s very unlikely that you’ll be able to integrate a legal structure which dovetails with your organisation from start-up through to growth. Besides, changing structure can actually allow you to develop and potentially enhance the way you run the business. That’s because different structures have varying levels of administrative filing and they will also impact on the amount of tax you have to pay.

If you’re seeing significant signs of growth then perhaps it’s time to think about what will best support the development and expansion of your business.

If you’re a sole trader…

In 2015, there were 3.3 million sole propritorships in the UK – making up 60% of businesses. There are clear benefits of operating as a sole trader, including the ease of starting-up and the taxation of income. However, alongside the benefits there are also inevitable downfalls, such as limited protection – exposing you to risks and limited finance options.

If you have a proven viable business model that's growing, you’ll need a lot more out of your legal structure than just simplicity so it’s likely to be time to make a change.

An evident risk of operating as a sole trader is the lack of personal liability protection – both the business and personal assets are viewed collectively, so if your business is in debt, you’re personally liable for all the money owed. Sometimes to achieve growth you need to take risks to develop your product or service, meaning you’ll likely need a structure that protects your personal liability should things not work out as you hoped.

 

If you’re operating under a partnership…

Operating in a partnership is fairly similar to a sole trader, the predominant difference being that you have a business partner with whom you share liability and decision making. This naturally opens more opportunities for growth as there’s more heads in the business, whilst also providing more fund raising options.

A key feature of this structure is that the profit which is generated is not subject to corporation tax. Whilst it is necessary to prepare accounts for a partnership, the entity does not need to be registered with Companies House and is therefore free from the associated administrative burden and filing deadlines.

When it comes to personal liability, you and the business are treated as a collective whole. Each partner is responsible or liable for the other partner’s negligence or misconduct. That means any one partner could be liable for the total debts of the partnership. You’ll likely want to protect yourself when growing your business so it may be preferable to consider a limited liability partnership instead.

Incorporating a limited liability partnership (LLP)

The LLP structure works whereby it protects members’ assets, subsequently limiting their personal liability to the amount they have invested in the business and any personal guarantees they may have given when raising loans.

Where an LLP is similar to a partnership is in relation to tax. Like a partnership they are treated as transparent and not subject to corporation tax, or, capital gains tax. Limited liability partnerships do have to register at Companies House, along with a members’ agreement stating the share of the profit each member should receive.

Whilst this means administrative requirements it can also help make the next phase of growth attainable because becoming a registered partnership can work in favour of attracting investors. Potential backers like to see publically available information about a business as evidence of its operation and performance when considering whether to provide funding.

Incorporating a limited company (Ltd)

Registering your organisation at Companies House ensures you as the owner(s) have limited liability. It’s important however, to be mindful of the stress and time you could spend filing year-end accounts, as well as other additional admin. A limited company is owned by its shareholders and operated by its directors. It’s governed by the ‘Memorandum and Articles of Association’ which forms a contract between the company and its members.

A perk of running a limited company is the protection of your personal liability, as the company is seen as a separate legal entity to the company directors – ultimately allowing you to take business risks, which sole traders may be apprehensive about because of the associated exposure to substantial personal loss.

Psychologically there is a perception that a limited company has more of a business standing when it comes to raising finance or attracting and dealing with larger customers and suppliers. Owner managed limited companies also present several flexible & efficient tax planning opportunities not afforded to members of unincorporated partnerships (such as sole traders and partnerships). Professional advice should always be sought in exploring these further.

 

Now think bigger…

With expansion will come additional structural issues. If you grow to have several outlets, offices or divisions, you’ll be faced with the question of keeping everything under one roof or establishing them as different businesses. Again, your choice will impact on the level of filing required and the amount of tax you owe as well as how exposed each part of the business is to the success or failures of the others.

The time to think about these things is now because growth, especially fast growth, can creep up on you along with the challenges that come with it. You should also consider shareholders and which parts of the business will they have a stake in, some of it or the whole thing.

This is also particularly relevant if you’re looking to obtain further investment and/or you’re seeking to retain key staff through employee incentive options. To make things as simple as possible you’ll likely be faced with three options:

  • 1. Independent

Each part of your business continues to trade independently meaning there is no formal legal, accounting or tax association.

  • 2. One big entity

All parts of the business fall under one large organisation whereby they function as departments within it.

  • 3. A holding operation with trading entities    

You have a main holding business with each component part functioning as a trading entity that comes under the ownership of the holding operation.

Consult your accountant carefully to understand which treading vehicle will best support you during growth. As part of this think carefully, especially if you’re scaling, as to how you will structure the different components of your organisation with expansion. Ultimately much in business is about planning and as the saying goes, “fail to plan, plan to fail”. 

 

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The content of this post is up to date and relevant as at 31/03/2017.

Please be aware that information provided by this blog is subject to regular legal and regulatory change. We recommend that you do not take any information held within our website or guides (eBooks) as a definitive guide to the law on the relevant matter being discussed. We suggest your course of action should be to seek legal or professional advice where necessary rather than relying on the content supplied by the author(s) of this blog.

 

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