Sole trader, partnership, LLC or co-operative? Setting-up in business correctly is essential

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Choosing the right legal form for their business is a key step on the road to success for many small business founders.

A business’s success is dependent on a number of inter-related issues – social and economic – and ACCA’s report advises that when first starting-up, an important consideration is the legal form of the business.

The report helps advisers and entrepreneurs understand the importance each might attach to some of the factors influenced by the business’s legal form, and help them discuss the different options, examining the administrative, regulatory and legal issues.

It sought views of professional advisers in practice, existing small business owners and those considering the founding of a small business about what was important to them when considering setting up in business – from tax incentives to compulsory business registration and regulation.

The group most in favour of tax incentives those looking to set up their first business, with 45% that tax measures should be the primary incentive for small businesses, compared to just 30% of those who have already set up a business, and only 18% of advisers who have set up their own business.

Jason Piper, head of business law and tax at ACCA says: ‘To every small business founder, the success of their venture matters a great deal. It’s a fundamental element of being a business that it has to interact with the outside world – relations with customers, investors, regulators and suppliers can’t be avoided, but the ease with which those relationships can be established, that effectiveness with which they can be managed and ultimately the manner in which any disputes can be resolved will be characterised by the legal form which the business assumes.’

There are a number of forms a business can take, depending on local laws:

  • Sole trader: The easiest looking option, and often involving little or nothing in the way of formalities, but also usually the riskiest. The business owner will be liable for any debts or damages beyond local bankruptcy protections, potentially putting anything at risk. It can also be difficult to expand, as lenders are likely to be most cautious with this type of business.
  • Partnership: Comes in various forms, and may often expose each partner to unlimited liability not just for their own decisions but also those of their partners. However, the pooling of resources can offer greater stability and growth prospects. Some jurisdictions offer limited liability variants, which can temper the risks. The partnership may also be able to own and borrow against assets in its own name as a separate legal personality.
  • Limited liability company: Usually the most formalised option, this is invariably a separate legal person with enduring capacity – that is, it will continue to exist even if the owner dies. It can own assets and enter into on its own behalf, and raise funds in its own name. A further benefit is that where ownership is , investors can take a transferable share in the business itself – and any future profits – rather than just lend funds at a fixed return.
  • Cooperative or mutual business: Often used where the goal is more than mere financial gain, these can come in many forms, some similar to partnerships and others adopting modified company formats with limits on profit distributions. Anecdotal evidence that society is moving more towards non-financial measures of success is backed up by the survey findings from aspiring entrepreneurs, 68% of whom think such business forms are needed.

ACCA’s report also looks at what it means to be a director – the people who control and manage a company’s affairs on behalf of its shareholders.

Jason Piper explains: ‘It’s the directors who usually have the power to take all or most of the important decisions regarding the running of their companies. The overriding principle is that directors owe their duty to the company, and not to any third party – including themselves. That can have significant implications if things don’t go as planned.’

For those looking to set up in business, ACCA recommends people seek advice from qualified individuals, professionals with recognised qualifications who can advise on first steps but importantly offer guidance on next steps and business growth.

Future business owners should also try to educate themselves on the differences between different types of business incorporations and get an idea of what would best suit their business model. For example, knowing whether their LLC should become an S-Corp or not can potentially save a lot in taxes.

Jason Piper concludes: ‘Advisers should be prepared to explain clearly to their clients what legal, administrative and regulatory burdens exist for business forms, and why. Setting up in business is risky, but with these risks come great opportunities to grow and achieve ambitions.’