Setting Up in Business
Choosing the Form of the Business

When starting a business, there are limited forms of legal entity to choose from. The main form of a business are:

1. Sole Proprietorships
2. Partnerships, and
3. Companies.

Each form of business is different and has its own advantages and disadvantages.

1. Sole Proprietorships

A sole proprietorship is a business run a person in their own right. A person is a legal entity. A person enters into contracts every day of the week, when travelling (purchasing a ticket is a contract of carriage), and purchasing anything whether it is a holiday or a car. There is no substantive difference between a person doing these things and trading in their own right, by purchasing supplies, providing services of whatever nature.

Consequently there is no distinction between the person and the business. The person is the business, and is revenue from the business is received by taxable income and a personal liability arises to the Inland Revenue to pay that tax. If the business runs at a loss, the individual is personally liable for the debts of the business, again because the person is the business.

This status as a sole proprietor is the simplest form of business, with the lowest overheads and as the person is the business quite flexible. The significant risk however for sole proprietors is that the person is exposed to all liability if something goes wrong. For instance, if a software developer operates a business in his own name and an error in the software causes (say) a web site to go down and the business who engaged him to build the website sues him for damages, all of the software developers’ personal assets are potentially at risk to compensate the aggrieved party for the losses sustained by the failed web site. This may mean a person’s house, car, and any other assets may be available to satisfy a judgement debt. This is known as personal liability.

2. Partnerships

Section 1 of the UK Partnership Act 1890 defines a partnership as a ‘relation[ship] which subsists between persons carrying on a business in common with a view of profit’. Partnerships are flexible business model that allow sharing and bringing together of human resources and labour, financial resources, and experience.

Partners are personally liable for the act of their fellow partners. Suppose three partners are in business together and one of those business partners says something that is untrue about a product that the business sells. The other two partners, as well as the partner who made the statement is liable for the statement, and all of their collective assets are available to satisfy any liability for untrue statement. This is known as joint and several liability. ‘Joint’ is a reference to all of the partners and ‘several’ is a reference to the liability that all of the partners are independently liable for one another’s act and omissions. So in the case of partners, a partner’s assets who any nothing to do with any wrongdoing may be used to recover losses caused by a partner involved in the wrongdoing.

Properly established, the terms of a partnership are established by a formal partnership agreement which usually sets out responsibilities, profit sharing, and expense sharing. Writing however is not required for a partnership to exist. In the UK, s 2: Partnership Act 1890 sets out factors that are taken into account in determining whether a partnership exists automatically, that is to say by ‘operation of law’. Those factors are:

1. Joint tenancy, tenancy in common, joint property, common property, or part ownership does not of itself create a partnership as to anything so held or owned, whether the tenants or owners do or do not share any profits made by the use thereof.
2. The sharing of gross returns does not of itself create a partnership, whether the persons sharing such returns have or have not a joint or common right or interest in any property from which or from the use of which the returns are derived.
3. The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but the receipt of such a share, or of a payment contingent on or varying with the profits of a business, does not of itself make him a partner in the business; and in particular:

1. The receipt by a person of a debt or other liquidated amount by installments or otherwise out of the accruing profits of a business does not of itself make him a partner in the business or liable as such;
2. A contract for the remuneration of a servant or agent of a person engaged in a business by a share of the profits of a business does not of itself make the servant or agent a partner in the business or liable as such;
3. A person being a widow or child of a deceased partner, and receiving by way of annuity a portion of the profits made in the business in which the deceased person was a partner in the business or liable as such;
4. The advance of money by way of loan to a person engaged in any business on a contract with that person that the lender shall receive a rate of interest varying with the profits, or shall receive a share of the profits arising from carrying on a business, does not of itself make the lender a partner wit the person or persons carrying on the business or liable as such. Provided that the contract is in writing, and signed by or on behalf of all the parties thereto;
5. A person receiving by way of annuity or otherwise a portion of the profits of a business in consideration of the sale by him of the goodwill of the business is not by reason only of such receipt a partner in the business or liable as such.”

3. Companies

The difference between sole proprietors, partnerships and companies is that the company has a separate legal existence to the people involved in the business.

A company therefore is an independent legal entity. Employees are engaged by the company, invoices are issued and received by the company, the company may sue or be sued by third parties, rather than on behalf of the officers of the company.

Due to this separate legal character and personality, the shareholders and directors of a company are insulated from liability for the acts of the company, with some important exceptions. The exceptions take effect when there is some form of reprehensible conduct by the company officers, such insolvent trading or fraudulent conduct.

The company officers, which includes the directors, company secretary and employees act for and on behalf of the company. The suffix “Limited” or “Public Limited Company” is a reference to the status of the legal entity as a company. These suffixes originally to put persons on notice that liability of those working with the company had the benefit of limited liability, as opposed to personal liability for the acts and omissions of the company.

Setting Up Companies

Setting up a company involves registering the entity at Companies House. On balance, running a business as a limited liability company is more probably advantageous than the incumbent exposure to risk that comes with trading in one’s own name as a sole proprietor or as a partnership, even in consideration of the expense that may be required to establish the entity and maintain the entity. Limited Liability Partnerships (LLP's) are a permutation of a company, that has the benefit of being subject to a lower taxation rate.