When setting up a business one of the first considerations you will have to make is what business structure you should choose. The common options are whether to operate as a limited company, a sole trader, partnership, or a charity!
In this episode of ‘I Hate Numbers’ I talk about the options available for choosing your business structure (also known as business form), and how to decide. Mini spoiler alert if you are your own boss then you are self-employed!
Once a decision is made your actions will have consequences in a number of areas, including
In most things in life and in business there are always options. That is no different when it comes to deciding on your business structure.
Many end up with a business structure by default, without thinking what is best for their business now, and for the future.
This episode lays down the foundations (excuse the play on words) for
Your business structure can change and evolve over time. You can even have differing types to suit how your business empire is made up, and where you are in your business cycle.
In my next podcast I get down and dirty with money and taxes. Different business structures = different tax consequences
Grab a coffee, make yourself comfortable, sit back and listen.
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You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now, here's your host, Mahmood Reza.::
Good morning, everyone. Welcome to another weekly episode of I Hate Numbers. I'm your host, Mahmood. This is the show that has nothing to do with hating numbers. Far from it. My mission, my aspiration, my purpose in life, believe it or not, is to get business owners out there better acquainted with their numbers.::
Those numbers that tell you the truth, those numbers that guide you through times of calamity, those numbers that help you in times of prosperity and in times of calm, it's a cool thing to get a bit closer to your numbers. You're never going to actually probably fall in love with them the same way that I do,::
but really we need to try and dig deep and have a stronger association with those numbers. So, what's the show about this week? One common conundrum that goes through lots of businesses when they start, or whether they're actually got an established business cycle, is what business structure should we be.::
And what do we mean by that? Let's start with a couple of terms here, first of all. Now, if we hear the term self-employed, pretty much most business owners are self-employed. Self-employed means that you work for yourself. You are your own boss. You are the one who gives yourself a hard time if you haven't quite delivered. You are the one hopefully going to pat yourself on the back::
when things are going well. You work for yourself. You don't work for somebody. Now, we're talking about self-employed in a conversational term, and we're actually going to now lay down the tracks of the different business structures here, and that term, self-employment, has a different meaning when it comes into the world of tax offices and it comes to the world of legislation.::
But fundamentally, we start from that proposition. Self-employed means you work for yourself. You run your own business. You don't work for another person. And how you decide to have that business form, you've got pretty much four key choices. We're going to run through what those four key choices are. Towards the end of the show,::
I'm going to flag up some other models, some other forms that you may have come across, and those choices will be dependent on the type of business that you have and what your customers are, your market, and all the rest that are involved. Now, what are these four key possibilities? Well, probably the most common one where lots of businesses will start their lives, and that is what's called a sole trader.::
Now, it doesn't mean you're actually on your own and you've never engaged with anybody else. It means your business structure is such that you are the owner, I'm going to use that term very loosely, of your business. Any profits that you make, and let's be real, profits have got to be in that crosshair somewhere, all that profit is yours.::
What it also means, though, the flip side is any losses that your business makes, which is quite typical, certainly in the earlier stages of your business, you'll be exposed to that. What’s the advantages? Well, it's relatively straightforward in terms of compliance, in terms of paperwork to get yourself up and going.::
There's not really any sort of legal professional costs that you need to incur to get that business off the ground as a sole trader. There's very little emphasis in terms of the legalities and the framework of when you have to send your account in the format that it's got to be presented in. A big downside is if anything goes wrong in your business from a financial perspective, in terms of financial debt, in terms of something goes wrong, you as an individual, are personally liable and exposed.::
There is the tax side of things as well and I'm just going to mention this briefly here because today is just about laying down the foundations, the tracks, so to speak, about those different forms. Next week's podcast is going to be talking specifically about this world of tax and how it affects those different business structures.::
Another thing to bear in mind about sole traders is some people have a perception that if you're a sole trader, you are not a proper business, which is a bit of a ridiculous perception, but it's still a perception that still exists. Let's move on to the second type. The second type of structure that you may have heard of is what's called a partnership, and a partnership is as it implies. It's literally where you as a sole trader form a collaboration,::
that's how I would look at it, between yourself and more individuals. Those individuals in your partnership, by the way, can actually be companies perversely or not. So, now, there's some flip sides. So, when you team up with somebody, so you're not bringing them as a supplier, but you're working with them as a partner, that's great.::
You can share skills and talents. You may be an expert in your particular line of work, but you may lack marketing skills. You may lack finance and business skills. So, therefore you think a partner is ideal for you. They share also the responsibilities of running that business. So, if it works well, you can delegate tasks, delegate responsibilities.::
You've got collective thinking there. You can also inject and raise more funds if you're a pool of talent and as a partnership. There is some regulation there in terms of what's called a partnership act that exists in most jurisdictions that will govern how you share profits, who does what. In my experience, lots of partnerships tend to be between maybe husbands and wives, family members.::
There doesn't tend to be much formality in having what's called like a partnership agreement. I would certainly suggest that if you are going down a partnership route, even if it is husband and wife, brother and sister, friends, that you have some form of heads of agreement outlining what each person does, how those profits are going to be distributed, in what share.::
You may have one partner who does a lot of more work, therefore they should be compensated accordingly. Now, there's a flip side as there is in all of these things in life, and the flip side is that one partner's decision binds everybody else in the partnership to what their decision is. So, if somebody's a little bit reckless or, you know, that's one of those things in life, they make a decision which isn't really going to be positive for the partnership,::
the whole partnership is bound by that decision. It's really a collective responsibility, if you wish, of one partner saying something, everybody else is committed to that decision. Certainly, when it comes into the area of making contracts, getting supply agreements, that could be quite a challenging thing.::
There is another downside to a partnership. Now, I've seen lots of partnerships in the years that work very well, but I've also seen lots of partnerships crash and burn, and these are between family members. These are husband and wife, and typically probably not as much with husband and wife, but it does happen is when money enters the equation, as the business grows, as the business prospers, what tends to happen, if there's not been much transparency and things break down,::
is individual partners become sometimes quite resentful because they feel they're contributing a lot more effort and work. They're not getting an adequate share of the spoils, and therefore it can break down accordingly. So, transparency, good communication is certainly a key to get that partnership working effectively.::
The third most common way that businesses form themselves. Let me just pause at this stage before we delve into companies. What I need to say at this point is if you run a business and you do a variety of things, it's very possible, just like a sweet shop, you can pick and choose. So, some of your business activities could be run as a sole trader and a sole trader, by the way, doesn't mean it's just you by yourself.::
As we said earlier, sole traders can employ staff. Sole traders can be quite big entities, but you can have a part of your business activity run as a sole trader and you can have some of your business activities run through a company. If it's appropriate, some of those business activities can be run as a partnership.::
Obviously, that means there's a lot of management issues going on, but there's nothing in law that says you can't have multiple business structures. One thing I would certainly say is before you dive in to choose one, your business structure has got to reflect the nature of what your business activity is and your attitude to a certain number of things, which I'm going to explain in a few moments.::
Let's get back to the company. Now, a limited company is as it implies. So, typically the formation of the company nowadays is relatively light touch. You can either do it as a DIY, you can either come to companies like myself and say, Mahmood, we want a company formed. And the procedure is largely administrative.::
If it's quite a complex thing, so you're more than just a one-person operation and you've got other directors involved, there's going to be a lot more formality - things like directors agreements, there's going to be things like you might want to change some of the rules of the company, but largely compared to, say, 20 years ago, the procedures are much more light touch.::
So, you create this legal artifice. So, it's a separate person in its own right, and the word person, certainly in legal terms, by the way, doesn't mean that an actual individual where you, you know, they've got arms and legs. A person can be a company. Now, a company that is created, by the way, is able to enter contracts in its own rights, is able to be contracted.::
It's separate from you as the individual. So, even though your mindset says, it's my business, you are self-employed, but your business structure in that case is a company. You can be self-employed and your business structure is a sole trader. Now, in the context of the company, what that means is couple of things on why it's favored by lots of businesses is because the risk element is very positive in the sense that::
if a company enters into a contract with somebody, it's this company that's created that is responsible for any things that go wrong. If the company incurs debt, and obviously if you've not been doing to do your cash flow, that's going to be a bit naughty, but if it does incur debt and there are business challenges ahead and you can't service that debt, it's the company that is liable for that.::
And if it's got no money in the bank, if it's got no assets, anything that you might have individually, houses, cars, and other assets are protected. There is a caveat, which I'll mention in a moment. You knew there was going to be a spoiler. I'll mention that in a few moments. Now, what that also means though, is the flip side.::
If somebody contracts with you, one of your clients wants you to do work, and that client is a company, if they're unable to pay their debt and you pursue them, then you'll find, individually, you can't go after them if they're a sole trader. As a company, that's the thing that you've got the relationship with there.::
So again, you need to fax that in. There are workarounds here and one workaround I would always recommend where you can is do what the banks would do to you. If you go to a bank to ask for credit facilities, for overdrafts, for loans, typically, most banks would want a personal guarantee, an undertaking that says if the company itself can't pay those bills, can't pay those debts, then we want you to underwrite those.::
I would certainly consider those in your own relationships with your own customers is to have a clause that says, if you are unable to pay your bills, unable to pay this debt, then we reserve the right to pursue you individually. Effectively a personal guarantee. Now, whether you'll get that through is a different argument.::
I certainly, in my business is when I take on a new client, have a personal guarantee clause embedded in there. The other main reason why people choose companies is this world of tax. And it is an argument for say, if I compare the two between a sole trader and a company, the tax bill, the tax slice, that inevitable thing in life where HMRC or whoever your tax authorities are, will take a slice of your money and tax,::
the tax burden tends to be less for a company compared to a sole trader. I would say that's largely true, but I would say certainly, taking the UK experience is concerned, that doesn't really apply until your profits go over a certain number, and typically you'll see a bigger differential kicking in when your profits in your business are such that you become what's called a higher-rate taxpayer.::
When you gravitate towards that end of the scale, then there's a stronger argument for becoming a company. The differential between the two tends to be quite small if you're what's called a basic-rate taxpayer. If you're sitting there thinking, my God, what's he going on about talking tax? Tax is that thing we've got to look forward to next week, and I'm going to give you an overview about what we're referring to by a higher-rate tax and how the tax works depending on the company vehicle and the business structure that you adopt.::
But for now, tax is certainly a consideration. Other things to bear in mind for a company is that you've got an extra bit of what I call compliance. When you hear the word compliance, don't get scared by this. All it means is, is when you publish accounts, they have to be in the public domain. Typically, if you're a small company, typically under about 5.6 million pounds,::
and it would be nice to get to that stage, wouldn't it? Your accounts that you file with the regulators tend to be quite light touch and you're not revealing lots of information, but you have to reveal some. That's to protect people who are engaging with you. It's a company, you've got a benefit of that protection, so there's a bit of a trade-off there, so it only seems fair and natural.::
Full structure. So, we've talked about the sole trader. We've talked about the benefits of that, the simplicity, the ease of getting started. We've talked about the downside, the responsibility if anything goes wrong. Personal debt as well. Some people say if you're a sole trader, you lack credibility. I think it's an argument. My own businesses,::
for example, one of them is run as sole trader and one of them is a limited company. So, I don't think after 25 years it's a credibility argument, but it's a perception nevertheless. Having said that, certain industries such as IT will not engage your services unless you run it through a limited company.::
So, you might find barriers if you remain as a sole trader. We talked about partnerships, that's that collective sole traders stuck together. We talked about the benefits of pooling resources, risks, talents, and time. If one partner is feeling a bit poorly, somebody else can step in. We talked about the downside.::
I will refer you to the War of the Roses, Danny DeVito film here if you want to see the downside of partnerships. Limited company, very popular vehicle. So, remember, you're still self-employed, you become now the shareholder, which sounds great, grandiose. You are the director of your own business company. You can call yourself an MD.::
You can call yourself a CEO, quite legitimately. It protects you. It also means that people will think that you can have a larger credibility. I would say that argument is probably slightly dented these days because somebody can quite easily check out the company, find out its history, find out its accounts, in terms of getting a snapshot here, but it still has that perception in the marketplace.::
You've got the compliance regime. You've got to complete those accounts once a year, which you have to anyway. You have to submit them to the entities - HMRC, Companies House typically in the UK. And we'll also add that the costs of preparation for company accounts, the professional fees involved typically tend to be higher than they would be for a sole trader.::
The fourth structure is a blend between a normal partnership and a limited company, and it's called an LLP. Now, it's not NLP, it's LLP, which stands for Limited Liability Partnership. Now, effectively, this is a great model. It started in professional firms like accountants and lawyers. It has been extended to things like property companies and the like, and effectively::
you've got the benefits of a partnership and you've got the benefits of a corporate umbrella. So, each of the individuals involved in that limited liability partnership get protection, but in terms of tax treatment, it is treated as your slice of the profits go onto your individual tax return. So great, bigger flexibility and as a model, I think that's gaining a lot of traction.::
Now, I want to mention before we wrap up the show other ways that you can structure yourself. So, if you are a not-for-profit entity, so in other words, any monies that you make are kept within your business, they're not used for your own personal reward, then you might want to consider what's called a CIC, a community-interest company.::
You might want to consider effectively a limited-by-guarantee structure, or you might want to consider a charity. They're not so much specialised, but they're quite unique, and we're going to talk about those on another day when we talk about not-for-profits. Okay, everybody, I'm going to wrap this show up now. Hope you've got some value from it.::
Obviously. Listen, share, tell your friends what a great show it is. Next week's show, we're going to talk about that wonderful world of tax. We're not going to push you to insomnia or stabbing yourself with a pencil, but you need to be aware of the different taxes and how they impact on those different business structures.::
What's my tip for you? Have a think about your business in terms of risks, rewards, impact on your future customers, and then think about which of those four potentially map back to your business structure. Have a great week everyone. See you next week. We hope you enjoyed this episode and appreciate you taking the time to listen to the show.::
We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.