Every business owner must grapple with a big question very early on in their journey: Which business structure will they opt for? The structure you choose will have significant implications for your legal responsibilities, tax obligations, and operational flexibility.
In this blog post, we’ll dive into the pros and cons of the three most common business structures to help you make an informed decision that aligns with your goals and circumstances.
Sole proprietorships
Being a sole proprietor of a business (more commonly known as a sole trader) is the most common and simplest structure. The owner is personally responsible for all aspects of the business, including finances, decision-making and liabilities.
Pros
Working as a sole trader is relatively straightforward and cost-effective, making it an attractive option for new ventures. You also have full control over decision-making and your operations.
In some cases, sole traders can benefit from more generous tax treatment. This is because sole traders pay income tax and are entitled to a tax-free personal allowance. Therefore, if you’re making a small profit as a sole trader, you could pay less in tax than a corporation in the same position.
Cons
Sole traders are personally liable for any business debts or legal obligations, putting personal assets at risk if anything goes seriously wrong. Furthermore, sole traders face challenges when accessing capital and expanding their business.
Furthermore, while some people welcome being the sole decision-maker, that role can sometimes put too much pressure on the sole trader. Then again, sole traders can rely on consultants, advisers, bookkeepers, and accountants to give them advice about the business.
Partnerships
A partnership is a business structure where two or more individuals share ownership and responsibility of the business. Partnerships can take various forms, including general, limited, and limited liability partnerships (LLPs).
Pros
Partnerships allow for shared decisions, the pooling of resources and expertise among partners. So, if your business venture is particularly complex, expensive, or time-consuming, working in partnership with others could be a good option.
Partners are still personally liable for debts, just like sole traders, but this time, the liability is shared among the partners, providing a degree of protection.
Cons
You shouldn’t put too much faith in the ‘degree of protection’ a partnership offers regarding liability. After all, you are still liable for your debts, which is a very serious thing to consider.
Disagreements among partners regarding decision-making, profit sharing, or operational matters can easily arise, potentially leading to conflicts. You need to be ready for that possibility.
Furthermore, partnerships rely on the commitment and contribution of all partners, and disagreements or departures can impact business operations.
Corporations
A corporation is a legal entity separate from its owners (shareholders). For several reasons, corporations are quite different from sole proprietorships and partnerships.
Pros
Corporations offer their shareholders limited liability, meaning each shareholder is only responsible for their invested money. This shares the burden and protects personal assets from business debts and liabilities.
Corporations are also great vehicles for raising funds by offering investors shares in the business, which facilitates growth and expansion.
Additionally, corporations have a separate legal identity from their owners, giving you more options with succession planning, it will be easier to pass on or sell the business.
Cons
Corporations are subject to more extensive legal and regulatory requirements, including annual filings, shareholder meetings, and corporate governance standards. That can be stressful and time-consuming, although outsourced company secretarial services can help here.
Companies can also face less beneficial tax treatment. First, profits are submitted to corporate tax, and your salary will be taxed again through income tax—which is why many directors focus on dividends.
Corporations also do not have any sort of tax-free allowance. As such, companies making only modest profits may have to pay more tax than sole traders or partnerships. Then again, the top corporation tax rate is 25%, compared to 45% for income tax. Therefore, companies are the best choice (in terms of tax) when making high profits.
Struggling to make up your mind?
There are many differences between different business structures, so it can be difficult to decide which one is right for you. Don’t fret, though: we can help you decide. We’ll discuss the details of your business, examine your operations, and give you our opinion on your best choice.
Talk to us about your business structure.