Choosing the Right Legal Structure

As promised... Legal Structures! As an entrepreneur we have to decide the most appropriate legal structure for our business. There are several different types of ownership and each will come with their own separate implications on the business. 
Let's take a look...

(By being an entrepreneur we only have to concern ourselves with the unincorporated businesses and Private Limited. We will briefly look at PLC's but this is more for your A2 course.)

There are two main categories of businesses:

• Unincorporated - unregistered
• Incorporated - registered at Companies House

Our unincorporated businesses are:

• Sole Trader - owned and run by one person

As a sole trader you can one day decide to start trading. You may have made some cute Christmas cards and decide to take them to a local craft fayre. You have a good day and we sell all the cards that you took! Brilliant! All that profit made is yours to keep. Now you can decide whether you are going to reinvest your profit to buy more raw materials and therefore make more Christmas cards OR you can decide to spend your profits on a pair on new shoes!!! The choice is entirely yours.

However, things may be going swimmingly and you've started making some money (as well as treating yourself to the shoes!) and you decide that you think you want to open an actual store to sell your cards from. Things start off okay but then Christmas has passed and people aren't so keen to pay for greetings cards. The rent on your storefront still needs to be paid... uh ohh... 

As a sole trader any debts you incur are entirely YOUR responsibility - you have unlimited liability. You have no separate legal identity to your business which means your personal assets can be seized to cover the debts. (Hide the car, cat and kids!!!)

So maybe a sole trader isn't for you, it's okay, you could decide to bring in your best mate - two heads are always better than one! We can bring in both our skillset and operate as a:

• Partnership - owned and run by two to 20 people. Before we begin trading we can draw up a Deed of Partnership which legally states the responsibilities of both parties involved.

As a partnership we can again one day decide to start trading. We may have made some wicked Tee's all from recycled materials and there is a student event on in the local town. We have a good day and we sell all our tee's that we took! Brilliant! All that profit made is ours to keep. Now we have to make a joint decision as to what we do with our profits. Do we reinvest our profit to buy more raw materials and therefore make more tee's OR do we split the profit 50/50 and we can decide how to spend our individual cut - maybe a new Xbox? The choice must be unanimous which means it is very easy for conflict to occur.

However, things may be going swimmingly and you've started making some money (as well as treating yourself to the Xbox!) and you both decide that you think you want to open an actual store to sell your tee's from. Things start off okay but then winter has finally come and people aren't so keen to pay for tee's. The rent on your storefront still needs to be paid... uh ohh...

As a partnership any debts you incur are entirely YOUR responsibility - you have unlimited liability. You have no separate legal identity to your business which means both your personal assets can be seized to cover the debts. (Hide the car, cat and kids!!!)

                                                        

Phew... that's a lot to take in!!! Maybe this unlimited liability is scary you a little and you wonder if there is a way you can remove this risk... aha... read on my lovelies...

Incorporated businesses

• Private Limited Company or Ltd - this is registered at Companies House (no - it's no longer a physical house - it is all done online!). You will provide Companies House with all your accounts, your Memorandum of Association and your Articles of Association. The Registrar will check through and hopefully give you the "nod" and HEY PRESTO! you become a company!

So as a Ltd we privately invite shareholders to join our business. We may get to a point where things are working as a sole trader but we feel now is the time to grow. We may have a bit of retained profit but ideally we could do with a cash injection. By registering as a Ltd we are allowing ourselves to access these pools of finance.

As a bonus of becoming a Ltd we also give ourselves limited liability. This means that should the business get into any debts, we are not personally responsible to repay the sum. Our personal assets are safe and we only lose the money we have invested in the business... (you can go get the car, cat and kids back now!)

However... our shareholders aren't going to just give you their money in exchange for nothing... oh no... they're going to want something in return.

You need to look after your shareholders because they are the ones allowing you to expand. To keep shareholders happy we must offer them the following:

• a share of the profit known as a dividend
• a 'say' in the running of the business and a right to vote