Now that you’ve decided to freelance, you’ll need to choose a legal structure for your business.
So it’s probably a good time to look more closely at the business structures available to you. We’ll explore what they are, how they differ legally and what the tax implications are in each case.
There are more options for larger businesses, but for freelancers the three main choices are:
Sole trader
Partnership
Private limited company
The structure you choose will depend on a number of factors. These include:
How much you expect to earn
What liabilities you or your business could be exposed to
The administrative costs of setting up and maintaining certain business structures
The future plans for your business
Who you do business with
How you want to be perceived
How these relate to each company structure will become clear as we look at each of them in more depth.
1. Sole trader
What does it mean?
You’re the only owner of your business. It means you get to keep any profits and are responsible for declaring your income tax each year through the government’s self-assessment tax system (we’ll talk more about this in the next chapter).
Why it’s a good idea
Setting up is quick and easy and won’t cost you anything. You also won’t need to register your company with Companies House, which means your financial situation remains private.
Why is this right for me?
If your business is small, you’re freelancing in your spare time (earning money from a hobby perhaps), or not earning very much this is the best option.
If you’re just testing the water and not sure if you want to freelance permanently, this structure also allows you to easily change your mind if you decide it’s not for you after all.
What are the drawbacks?
There is no legal separation between you and your business. Therefore, if your company owes money or gets sued, you are personally responsible for these liabilities. If you’re unable to pay any debts, it could mean paying your bills with other assets such as your home.
You can also be perceived by some employers as less credible or professional, and some may refuse to hire you because of this.
2. Partnership
What does it mean?
Partnerships function similarly to sole traders in that you won’t need to register your business with Companies House. Each partner must also pay tax through the government’s self-assessment tax system.
However, partnerships are different from sole traders because they involve more than one person.
Why it’s a good idea
Because there are more people involved, you’ll potentially have more money to set up. You may have different skill sets, which means you can share the responsibility of running the business and find roles that naturally suit you.
Why is this right for me?
If you are planning to start a business with one or more friends or family members, this is the sensible option.
What are the drawbacks?
A big problem can be disagreements, which can damage the business as well as your personal relationships. Resentments can happen if one person feels they are putting in more effort.
Profits are shared equally between the partners, but so are liabilities. Again, just as with sole traders, both partners are personally responsible if the company falls into debt (this can be avoided by setting up a Limited Liability Partnership, which limits each partner’s liability to the money they put into the business).
3. Limited company
What does it mean?
There are different types of limited companies. Freelancers usually opt for a private limited company where ownership is split into equal parts and shares are issued. All limited companies must be registered with Companies House.
You’ll have to keep more complex accounts and submit these annually along with other statutory documents each year.
Why it’s a good idea
A limited company is a completely separate entity from its owner. If you choose this option, you’ll probably be the only shareholder and director with a nominal share cost of £1, which means if the company falls into debt, you are not legally liable to pay its debts.
You can also sell shares to raise finance.
Why is this right for me?
Some companies will insist you register as a limited company before they’ll do business with you, so check the situation in your industry before deciding. Operating as a limited company can also offer attractive tax planning opportunities, which means you can end up paying less tax overall.
You will not be personally liable for any debts or other liabilities incurred by the company.
What are the drawbacks?
There is more paperwork involved as you’ll have to submit annual company accounts and figure out how much corporation tax you owe. You’ll probably have to hire an accountant, which will incur additional costs. Profit is held in the company, so is not as easily accessible.
Anyone can gain access to your annual accounts through a simple search on the Companies House website. You can work as an employee of your company, which means you’ll need an accountant to set up a PAYE system for you or you can register for self-assessment.
What if I still can’t decide?
Consider getting professional advice from an accountant about which option is right for you. If you don't know one already, you can find a qualified financial accountant with The Institute for Financial Accountants (IFA).
If your business is going be trading abroad, consult an international accountant. To find one, visit the Association of International Accountants (AIA).
Let's recap!
Decide the right structure for your business.
Discover sources for further advice.
Now that you have a clearer idea of the three main business structures, you’ll need to inform the government of your decision. We’ll look at how you do this in the next chapter.
