When starting a business, an entrepreneur must decide what form of entity to establish. There are four main entities to choose from and each has its own benefits and drawbacks.
A sole trader is the simplest and cheapest entity available. An entrepreneur who chooses to operate as a sole trader trades on their own and is legally responsible for all aspects of the business. They do not receive a salary. Instead, they receive profits that are taxed as income.
A partnership is an association of people who wish to start a business and distribute any income or losses between themselves. A partnership can be ordinary, meaning that the partners are personally responsible for the business’ losses, or limited, meaning that the partners are only personally responsible for the business’ losses up to the amount they initially invested in the business. All partnerships must be registered with Companies House and each partner must pay income tax on their share of the partnership’s profits.
A limited company is the most common type of business entity in the UK. Its main draw is that it enables an entrepreneur to keep their business’ finances separate to their personal finances. Limited companies can be limited by shares or by guarantee. Most limited companies are limited by shares. This means that the shareholders’ responsibilities for the business’ financial liabilities are limited to the value of the shares they own but are yet to pay for. All limited companies must register with Companies House and the individuals who run the company – the directors – must pay tax on their salaries.
Community Interest Company
A community interest company (CIC) is an entity designed for entrepreneurs who wish to set up a business and use the profits for public good. Its structure prevents the profits from being distributed, except as permitted by legislation. An entrepreneur must register their CIC with Companies House and pay tax in the same way as an ordinary company.
It is important for an entrepreneur to understand the differences between the entities before starting a business. The entity chosen will affect their legal responsibilities, such as the paperwork they will have to fill in and the tax they must pay.