What choices do I have for the legal form of my business?

If you will be the sole owner of the business, you can trade as a sole trader. You are self-employed, and there is no separate business entity. You can be a sole trader even if you have employees working for you.

Alternatively, you can form a limited company.

If there will be more than one owner of the business, then you can trade as a limited company, a partnership or a limited liability partnership.

What are the advantages of forming a limited company?

A limited company is a separate legal entity, distinct from its shareholders and directors. This makes it a flexible way of involving other people - for example, as investors, directors or employees. Forming a limited company is often advantageous if you plan to grow the business.

A limited company also offers you the protection of limited liability. This means that your risk of loss is normally limited to the money you invest in the business (as share capital or through a loan). To some extent, however, this benefit can prove illusory: if the business needs to raise further funds, you are likely to be asked to provide a personal guarantee. You could also be held personally liable as a director if you allow the business to trade wrongfully or fraudulently.

On the downside, a limited company involves more administration and some costs. One option which suits some businesses is to start as a sole trader, and then form a company later on as the business grows.

Separately, you also need to think about the tax implications. Company profits, and any income you (or other employees) take from the company, are taxed differently from income as a self-employed sole trader (or from trading in partnership). The most tax effective business form will depend on how profitable your business is, and whether you will be reinvesting profits in the business or taking them for your personal use.

When would it be better to set up business as a partnership?

In an ordinary partnership, there is no limited liability: each partner is liable for the business debts of the partnership. This can help ensure that the partners are committed to the business - but equally, it can be personally disastrous if the business fails.

Separately, partners in a partnership pay income tax (and National Insurance contributions) on their share of the profits. Depending on how profitable the business is, and whether the partners want to reinvest in the business, this may be more or less tax-efficient than trading as a limited company.

In some cases, trading as a partnership is an attractive way for two or more people to form a business, particularly if the business risks are relatively low. But as the business grows, it is often a good idea to form a company: for increased flexibility, and to take advantage of limited liability. The main exception is in (the very few) businesses where you are required to trade as a partnership. In these cases, it is often advantageous to form a limited liability partnership.

Is it worth setting up a limited liability partnership?

If you are required to trade as a partnership, but are concerned about potential liabilities, then it may well be worth setting up a limited liability partnership (LLP).

Like a limited company, these are separate legal entities, distinct from their members. They have to be registered at Companies House and file accounts and an annual return every year but, in return, members enjoy the protection of limited liability. This means that your risk of loss is normally limited to the money you invest in the business (as loan capital). They are not as flexible as limited companies - it is difficult, for example, to bring in an outside investor who is not to be involved in daily management. As a member, you are taxed as if you are a partner in an ordinary partnership.

There are only a few thousand LLPs, compared to 1.4m limited companies. If you are not required to trade as a partnership, forming a limited company instead may well be a more satisfactory solution.