This article was written for the Daily Telegraph
The limited company should no longer be the default choice of business structure for entrepreneurs. Limited liability partnerships (commonly known as ‘LLP’s’) offer a number of benefits when compared with more traditional business models and are becoming increasingly common.
LLP’s were created in 2001 and were the first new business vehicle to be created under English law for nearly a century. They were designed to combine the flexibility and tax benefits of traditional partnerships with the protections of limited liability afforded to companies. The trade off is that LLP’s must publish on public registers similar information as for companies, such as annual accounts and the identities of its partners (who, somewhat confusingly, are properly referred to as members, rather than partners). LLP’s are particularly suitable for those who want the freedom to manage their business and divide the profits as they see fit, without many of the constraints that come with a limited company.
LLPs, along with sole traders, limited companies and general partnerships now form one of the four main alternatives for organising businesses in the UK.
An entrepreneur who does not actively make a choice as to legal structure will likely be a sole trader. A sole trader is simply the name given to an individual who carries on business on his own account (although he or she may well use a trading name). A common misconception is that the term ‘sole trader’ only refers to businesses which comprise a single individual. This is not the case a sole trader could have any number of employees, perhaps hundreds. The ‘sole’ in sole trader refers to the ownership of the business, rather than its size. The big disadvantage of sole trader status is that there is no distinction between the owner and his business if the business makes a big loss, the owner may go bankrupt.
Limited companies are often a good choice for those who are concerned about putting their personal assets at risk, as it is the company which is responsible for its debts, not its shareholders. The company is recognised in law as being legally distinct from its owners and so typically it is the company, rather than its shareholders, who own the assets of the business and be party to contracts. Company law imposes a fairly rigid structure on a business, with a board of directors managing the company on a day-to-day basis and shareholders receiving its profits.
Like LLP’s, companies must publish accounts and details of its owners and directors. A disadvantage of limited companies as compared with LLP’s is that company profits are taxed twice: corporation tax is charged on the profits when they are earned, and income tax is charged on the profits when they are paid out to shareholders. The effective tax rate may therefore be higher for income derived from companies than for LLP’s, which are tax-transparent (i.e. the profits are taxed in the hands of its members, rather than in the LLP).
General partnerships have declined in popularity in recent years. General partnerships offer simplicity, privacy and are associated with a collegiate culture between co-owners. However, these benefits are outweighed in most situations by the fact that the partners in a general partnership have joint and several unlimited liability for the debts of the partnership. This means that a rogue partner could bankrupt his innocent fellow partners. Because of this risk, many general partnerships have converted to LLP.
If none of the three main alternatives fits the bill, an LLP may be a good choice. Despite being called a ‘partnership’, LLP are in many respects more like a company than a partnership. Like a company, an LLP is an entity distinct from its members. This means that an LLP can hold assets and enter into contracts in its own name. Like shareholders in a company, the liability of members will ordinarily be restricted to the amounts invested into the LLP. Some elements of company law (such as the laws against fraudulent trading) are directly applied to LLP’s and their members. One way in which an LLP is more like a partnership than a company is in the tax treatment of its members. This means that an LLP does not pay employer’s national insurance contributions on profits paid out to its members, which can lead to substantial savings.
Unlike companies, the members of an LLP are free to decide how they wish their business to be organised internally and will typically document this in a members’ agreement, which is similar to a partnership agreement. Some LLP’s choose to organise themselves in a way similar to limited companies, but most prefer bespoke arrangements, whereby day to day management is handled by a board, but big decisions are put to a vote of all of the members. Profits can be shared in whatever way the LLP’s members see fit. This may be as simple as having equal shares, or be more of an ‘eat what you kill’ performance based system.
In an ideal world entrepreneurs should be able to focus on their business rather than its legal form. Whilst sole traders, companies and partnerships have their place, LLP’s offer a good compromise between administrative overhead and the protection of personal assets. Both start-ups and established firms should consider whether an LLP would be the best option for their business.