The legal structure you choose for your business has several important implications, including what activities you can pursue, what funding you can access and what obligations you will be subject to.
This choice can be extremely difficult and complicated, with so many options on offer, and as a conscious business owner you have additional considerations to make regarding the reputation of your business and the assurance of its ethical values.
In this blog post, I’ve summarised the options available to you when choosing your legal structure and outlined some of the pros and cons of each.
This is a lengthy topic with a great deal of information, but don’t worry, I’ve also included a free downloadable guide with some key considerations and simple comparison charts. You can get your download when you scroll to the end of this post!
As a quick disclaimer: I have not studied law, and the information and advice given here should not be substituted for qualified legal guidance. However, I hope that it will serve as a starting off point in helping you to make this critical business decision.
Unincorporated Business Structures
Remaining unincorporated can certainly be an easy way to start your business quickly and without having to complete too much documentation or raise significant funds. You can start trading immediately but must inform HMRC when you make over £1000 within the tax year (April-April).
As an unincorporated business, you’ll have full control over how your business is run and can experiment with different ideas before deciding on a final business structure which may be incorporated further down the line.
This also means that you’ll be able to follow your conscious purpose as you see fit, developing and promoting your personal values without risking their being compromised.
All profits you make, subject to income tax, will be yours to use and distribute in whatever way you like. You can easily pay yourself for your work, reinvest in your business or put your profits towards your social/environmental values. You will have fully flexible control over how this distribution is balanced and can change it at any given time.
Your accountancy fees will remain low, and you will be under no legal obligation to publish details of your business activities.
As an unincorporated business, you won’t need to register or file annual accounts/returns, and you will be less regulated than if you were operating as a company.
Instead, you’ll be taxed as an individual which means you will need to keep note of your income and expenses and complete an annual self-assessment for the HMRC. You will pay income tax on your profits and will have to register for VAT if you are turning over more than £85000.
One major drawback of remaining unincorporated is that you will be personally responsible for any debts or legal implications incurred by your business. This can put your personal assets, such as your home or your financial savings, at risk.
If you want to take on employees, you can do this as an unincorporated business, but you must inform HMRC and follow their guidance. Becoming an employer while unincorporated is likely to be more complex than as an incorporated company.
Another consequence of remaining unincorporated is that, without a clarified legal body to your business, you may appear less credible in the eyes of loan managers, investors and property regulators. You will likely struggle to access substantial funding opportunities or buy/lease any property.
If you are running your business on your own and have decided against incorporation for the time being, then you will need to set up as a sole trader and register your self-employment.
As a sole trader you will enjoy full control over your business’s proceedings and profits. You will be largely unaccountable, with the exception of the self-assessed tax obligations described above.
Being a sole trader can be a great way to get your business up and running if you plan to start or remain small. However, as an individual starting a business, you’ll likely have to take on multiple new roles which can be extremely overwhelming and time consuming.
It will be difficult to maintain any sort of work-life balance and can lead to a rather stressful and isolated lifestyle. If you plan to set up as a sole trader, it is important that you are truly passionate about your business and have a strong support network in place.
Finally, as a sole trader you will not have a clear, legally formalised succession plan should you choose or be forced to leave your business for any reason. If it is important to you that your work be continued, particularly if you are concerned that your ethical values could be compromised, then this might not be your best option.
Another option which does not involve incorporating your business is to form a general partnership.
While enjoying the unincorporated benefits of sole trader-ship as listed above (such as reduced documentation, regulation or obligation), forming a general partnership also allows you to gather the skills and resources of one or more other people.
Forming a partnership may also make it easier to raise finance for your business, partly because of the increased visibility and power of fundraising efforts, but also because responsibility for debt can be divided and therefore less risky to loan managers or private investors.
Setting up a partnership requires you to construct and sign a legal document which agrees with your partner(s) how profits will be shared, the extent to which each partner defines the business’s management and what will happen to the business should one partner choose or be forced to leave.
You might enter into a partnership with a friend, family member, loved one, colleague or even a relative stranger. Its important to be sure that you and your partner(s) are well-aligned, as control over the business will be split between you.
If your partner(s) do not share your ethical beliefs, this might lead to conflict over the direction in which you wish to take the business and the practices or measures you put in place to ensure your social or environmental values.
As general partnerships are unincorporated, your business will not be a separate legal entity. This means that you will still be liable for debts and legal issues, and although you have the benefit of sharing that liability with your partner(s), their responsibilities will default to you if they are unable to meet them.
Charitable Associations and Trusts
Charities are dedicated to supporting social or environmental causes. Setting up as a charity may seem the obvious choice if you are committed to the ethical values behind your business, but the decision is more complex than that and involves several other considerations.
To be eligible to register as a charity, your business needs to act for public benefit and have exclusively charitable aims.
As a charity, you will gain recognition for your ethical purpose and are likely to build a positive reputation. This will help you with public fundraising which is particularly useful if you are working towards a specific project.
You will also be able to access various grants and generous tax reductions. You will not have to pay income tax or corporation tax, and can gain from reduced business rates on property. As an unincorporated charity, property will have to be leased or owned on your behalf by someone external to your ogranisation.
Aside from raising funds through donation, charities are allowed to trade products and services. However, their trade and commercial activities are strictly regulated and they are restricted to trading in an area related to their primary purpose. For example, an animal shelter could sell collars, leads or pet food, but would not be able to start a cafe.
Unfortunately, lack of funding is a consistent problem for charities. Grants and donations are unreliable and unpredictable, which might make it difficult to plan your business endeavours. Reliance on such funding can often lead to ‘grant dependency’ where charity owners spend the majority of their time working on complex applications for funding rather that furthering their initial purpose.
Charities must distribute any surplus profit back into the business and its cause. Directors or trustees are usually unpaid, despite doing all of the administrative and management work of the charity. In founding a charity, you will likely have to sacrifice either your salary or your control of the organisation.
There are two types of unincorporated charity, either of which must register with the Charity Commission if their income will exceed £5000 per year. Unincorporated charities can be associations; which allow for a wider group of members to determine the actions and rules of the organisation by casting votes to the directors, or trusts; which are directed solely by trustees.
Wider membership is important to charities which rely on employed (including voluntary) workers or serve a large group of customers, as membership ensures that the voice of all stakeholders is heard in organisational decisions.
Charities must be set up by governing documents, which legally frame the rules of how the charity will be run. For an association, this should be a constitution while a trust would require a trust deed which lays out the organisation’s starting assets.
These rules must be strictly obeyed, meaning that associations and trusts are more heavily regulated than other unincorporated business structures. While this can seem intimidating, it also ensures that the running of your organisation will continue as determined even if you choose or are forced to leave.
As an unincorporated charity, trustees or directors have personal liability which means that their assets will be at risk should the charity fall into debt or face legal issues.
Incorporating your Business
Although incorporating a business is a lengthier and more complex process than remaining unincorporated, doing so can have several benefits.
Perhaps the most significant of these is the creation of a separate legal entity for your business. This limits the liability of the business owner, meaning that your personal assets will be safeguarded should your organisation fall into debt or face other financial/legal struggles (providing you have not committed an individual criminal act).
It is important to note here that this will not insure any personal investment you are putting into your business, and some banks or investors might still ask you to give personal guarantee in return for a loan which could put your assets back at risk.
Running an incorporated business means you will not be self-employed, rather you will be an employee of your own company. This means you can pay yourself a salary and even set up a tax-deductible pension.
As an incorporated business, succession planning becomes much easier. Should you choose or be forced to leave your business, its legal entity can be sold or passed on more easily than an unincorporated organisation.
Though your accountancy fees will be higher as a company, you will likely find it easier to access loans, investments and property as your business will have solid legal recognition. You may also be eligible for various tax deductions.
Incorporated structures are more heavily regulated than unincorporated, as you will have to register with Companies House and allow them to publicise details of your business. Companies House will also be able to hold you accountable to certain rules set out in your business structure and can penalise you for breaking these rules. Incorporated businesses must also file annual accounts and returns with HMRC.
Company Limited by Shares
Companies limited by shares can raise finance through issuing private shares. This means selling parts of your business to external shareholders, who could be dedicated investors or people you know personally.
Publicly Limited Companies sell their shares through national or international stock markets, allowing banks and members of the public to invest in their business. While this comes with additional prestige, public trading is mostly the domain of larger and more established companies.
A share is essentially a percentage of your business. If it is important to you to maintain control over how your business is run, including the prioritisation of your ethical values, then you will have to make sure that you remain a majority shareholder. If you give away too much of your business, you risk losing control its direction.
Companies limited by shares are primarily profit-driven, and this is likely to be the assumption of your shareholders. If you hope to build a reputation as an ethical business, you might have to work harder to display your values. Furthermore, you will have to be honest with potential shareholders about the returns they can expect, which may be off-putting unless you can convince them to align with your purpose.
You will need to keep a register (list) of how many shares are owned and by whom. You will also need to issue stock certificates which define the name of the shareholder and number of shares they own.
Companies limited by shares are unlikely to be able to apply for grants or receive donations, so you will have to be sure of your business’s ability to make profit. On the plus side, provided you maintain the majority share of your business, you will be able to decide what commercial activities your organisation is involved in and you will own your share of the profits.
As a company limited by shares, you will be accountable to your shareholders. You will have to meet their expectations else you might find yourself ejected from the management of your own business.
To ensure your ethical values remain part of your business, you can write them into your organisation’s constitution which will determine how your business is allowed to operate. Shareholders must agree with your constitution, and your incorporation with Companies House should ensure that constitutionalised rules are followed no matter your position within the business.
Company Limited by Guarantee
Companies do not have to be Limited by Shares, they can also be Limited by Guarantee. This is a common legal structure for charitable businesses and non-profits, as owners (also known as members) cannot extract or distribute any profits. Although salaries are allowed, any surplus must be put back towards the business and the cause it supports.
Companies Limited by Guarantee (CLGs) are not allowed to sell shares, which means they lose out on the financial opportunity this provides. However, it also means that they are not accountable to shareholders, which provides some protection for the ethical intention of the business.
CLGs do benefit financially from substantial tax relief and greater access to grants and donations. They generally have good ethical reputation which helps them to do well in fundraising.
As Limited Companies, owners are not liable for any financial or legal issues faced by the business unless they have committed a criminal act. The company has its own legal entity, which also allows for its straightforward succession.
Not all CLGs are charities, but they must be fully non-profit which can restrict your entrepreneurial activities and be less rewarding for owners. This will depend on your priorities, as the reward of furthering your social or environmental values may be enough.
If you want your CLG to be recognised as an official charity, then you will also need to register with the Charity Commission and comply with their regulation. If not, you can continue to act as a non-profit with strong commitment to your conscious purpose as a standard CLG, but you will not be able to identify your organisation as a charity.
Limited Liability Partnership
Limited Liability Partnerships (LLPs) are very similar to general partnerships in that governance and rights to profits are split between multiple people owning a business together.
You’ll enjoy the same benefits of having shared skills and resources, and will still have to construct a legal document agreeing the terms of the partnership.
Incorporated partnerships are also exempt from the double-taxation required by incorporated companies, and with a defined legal structure you will appear more credible than general partnerships to loans managers and investors.
The main difference between a general partnership and an LLP is that, as an LLP, your business becomes a defined legal entity. This means you cannot be held liable for the financial/legal obligations of your organisation or your partner(s). Your personal assets will be protected, with your only risk being the contribution you have already made to the business.
Charitable Incorporated Organisations
Charitable Incorporated Organisations (CIOs) are a relevantly recent legal structure for incorporated charities.
To set up a CIO, you must immediately register with both Companies House and the Charity Commission. You will have to create strict governing documents determining what you do, who you do it for and, as with unincorporated charities, you will need to have solely charitable aims.
You will be strictly regulated by the Charity Commission, who will require detailed evaluation of your business activities and accounts.
As an incorporated charity, it will be easier for you to employ a team, deliver products and services under contractual agreement, and own/lease your own property. You will be eligible for generous tax reductions, grants and donations.
If you want your charity to have a wider membership, you can set up an Association CIO with a constitution which should closely follow guidance from the Charity Commission. You will have to document both the trustees and the members of your organisation. If your charity will not have wider membership, you should follow the guidance for a Foundation CIO constitution, and provide a list of trustees.
CIOs have their own legal identity, meaning that owners are not liable for financial or legal difficulties of the business. Unlike a CLG, registration with the Charity Commission is non-negotiable. Your charity status can boost your ethical reputation and, should you choose or be forced to leave the organisation, the Commission’s strict regulation will ensure that your ethical values are maintained.
However, this regulation will limit the flexibility you have, as you will not be able to introduce any for-profit activities or engage in any non-charitable business activities. Once registered as a CIO, it is not possible to convert to a different legal structure.
Community Interest Companies
As an ethical business owner, you may also choose to structure your business as a Community Interest Company (CIC).
CICs are designed for enterprises with a distinct social or environmental purpose. CICs are incorporated companies and are distinct from charities. They can choose whether to be limited by shares or by guarantee, and will follow the general format of their chosen structure.
Starting or converting to a CIC model is quicker and easier than registering as a charity, and also gives more flexibility as owners are allowed to withdraw a salary and can easily engage in trade or other commercial activities.
CICs can be reassured that their ethical values will be held, even if owners lose their majority share or choose/are forced to leave the business, as profits will be subject to an ‘asset lock’ whereby a substantial portion is legally required to contribute to community wellbeing.
Only 35% of a CICs profits remain unlocked, which means that owners or other shareholders will have to understand and agree that their reward will be limited. This might put limitations on a CIC’s capacity to raise funds through selling shares.
CICs inhabit something of an ‘inbetween’ space when it comes to funding.
Essentially, they are legally allowed to gain funding in a number of ways – such as selling shares, applying for grants or receiving donations – so are in some ways less restricted than other structures, but they are also less appealing to profit-driven investors, loan managers, grant awarding bodies or donors with a preference for reputable charities. Furthermore, CICs are not entitled to generous tax reductions.
The flexible opportunities for engaging in and diversifying commercial activity can help CICs to overcome funding limitations, as they are able to experiment and expand their trade of goods and services.
To ensure that profits are used for community benefit, CICs are regulated by the CIC regulator and will be required to submit regular Community Interest statements.
This comes in addition to their responsibilities as incorporated companies of filing accounts and returns with Companies House and HMRC. Although this might seem like a lot of restriction, CIC regulation is generally less strict than that of the Charity Commission.
I must apologise for the wall of information here, but I do hope that it has been helpful. If you are still confused as to what structure is right for your business, download the free Waggle Dancers guide for key considerations and simple comparison charts. Get your download emailed to you by filling in the form below!