Starting up in Business
Choosing the right format
When starting out in business a choice has to be made as to whether to operate as an individual (sole trader, or if there is more than one person starting the business then as a partnership) or as a limited company. If you are serious about your new business then you will almost certainly want to start from day one as a limited company. The following points show why most business will work better in a limited company format. If very little growth is anticipated then many of the advantages are small. A very low turnover retail outlet, or a plumber simply selling his or her own time, might decide to trade as a sole trader.
Limited Liability
The original defining purpose of a limited company is to limit the business owner's financial liability. Any amount owed by the limited company can only be paid from the funds and assets of the company. Thus, if cash runs out e.g. because a large customer has failed to pay you or a large legal claim has been paid, then only the assets inside the company are used to pay the creditors. If there is a shortfall then the company will probably be wound up. As a sole trader, a shortfall in the business is made up from private assets even, potentially, the equity in your house. It should be noted that banks lending to a small or start up limited company usually require a directors guarantee, in which case any debt specifically owed to that bank will have to be found from personal assets if the company cannot pay.
Taxation and national insurance
Despite recent changes in the way dividends are treated in the tax computations of very small companies, there is still a clear saving to be had by trading as a limited company. Many factors need to be taken into account to calculate the savings to you. For a business making a profit of £30,000 there is typically a saving of over £2,000 in total payments made to HM Revenue and Customs when comparing a single person limited company to a sole trader. As profits increase, so does the saving gained by trading as a limited company. Most of the saving is based on a small salary being paid from the company, and remainder paid in dividends, thus reducing payment of any National Insurance. However a significant amount of tax is also saved if there is any element of reinvestment in the business. Against this some individuals require a higher salary, for instance for pension needs, which will reduce the tax and national insurance savings. Accountancy fees might be in the region of £1,000 more (depending on the business size) for a limited company compared to the same business trading as a sole trader.
Stand alone business
By trading as a limited company you have legally and practically separated your business from your personal affairs. At a personal level this allows clearer thought processes which can result in better focus and understanding of business performance. The company will have its own bank account and own financial records. It also allows the outside world to view and deal with the business for what it is, rather than feeling that the business is an extension of an individual with the potential complexities that can bring. Banks, employees, suppliers and customers will all often prefer to deal with limited companies. Ultimately if you are building a business that could be sold, this will be easier as a limited company compared to a sole trader business.
Other factors
Each limited company must have a unique name, this means that by registering your limited company you have prevented that name from being used in another limited company. Ownership and management can be separated in a limited company. This has little consequence in the early days of a business, but gives far more flexibility when looking at plans for expansion, investment or retirement. A limited company will have its name, address, shareholders, directors and secretary on the public record at Companies House. It will also have to publish a balance sheet each year. There are no such requirements for a sole trader; however a business will not usually want to hide from the public. In fact publicity is one of the driving forces of most businesses. Record keeping, VAT registration and returns, employment and salary records and most legal requirements are similar for both sole traders and small limited companies. Some additional rules apply to limited companies in terms of year end accounts and corporation tax returns however these are no more difficult than the general requirements applying to all businesses. Such items will be dealt with by your accountant.
Franchises
A franchise is a business system, usually with a predefined name, that is purchased and operated independently. Well known examples include Ikea shops and McDonald's restaurants. Although the system and name is created and defined by the original entrepreneur, additional branches are then purchased and operated by other business owners. If you are keen to own your own business but do not want the risks involved in starting from scratch, then a franchise could be ideal. Many franchise opportunities are advertised in this magazine. The cost of acquiring a franchise is two fold. Firstly there may be an upfront payment. The franchisor (the central owner) may require a payment from the new business owner to grant the franchise or licence. Secondly there will often be an ongoing commitment to pay the franchisor. This could be a percentage of all future profits or a commitment to purchase supplies only from the franchisor, or both. Usually the franchisor will provide a very detailed business system plan which must be followed. One of the reasons for the success of franchise operations is that the branches, or franchisees, all operate in a similar way; they will have a "familiar feel". Part of the specification will often be that the franchise is operated as a limited company, although this is not always the case. It will usually be beneficial to operate as a limited company from day one as the commitment and profits will generally be higher when starting a franchise compared to start a business from scratch. A word of warning. Business owners, whether highly successful or not, are attracted to the idea of creating a network of franchisees. As stated above, the central owner may receive large one off payments up front and a share of the ongoing profits from the franchisee branches. This leads to some franchise offerings being highly favourable to the central owner, but of little benefit to the new business owners. Whenever purchasing a business it is important to value what you are actually getting compared to simply starting a similar business yourself.
Incorporation
Having read all of this, you may be thinking that your sole trader business would really be better of trading as a limited company. Many thousands of small businesses have gone through the process of incorporation in recent years. A few years ago the tax savings for even the smallest businesses were larger than they are now, however savings still exist and there are still often more advantages than disadvantages to incorporation for all but the very smallest and simplest businesses. The actual cut off as to whether a limited company offers tax savings that outweigh additional accountancy costs depends upon the individual circumstances. In many cases, where dividends can be paid to the business owners, the cut off is around £30,000 annual taxable profits.
Micro Business
If you are trading with no employees and low profits or a small number of customers then the sole trader format might suit you. Examples where this apply might be an odd job man, a home based building services supplier (plumbers etc), or a single retail shop with small profits. Such businesses, with no plans for expansion or reinvestment of profits back into the business, may not be any better off trading as limited company. One of the main factors cited for not wanting to trade as a limited company is the additional paperwork and regulations. In practical terms the paperwork is little different from for any VAT registered business. With the VAT threshold currently £60,000 all but the very smallest of businesses will have to VAT register and therefore not be faced by additional day to day paperwork simply because they have chosen a limited company format. On a day to day basis I see many successful businesses. Occasionally I am introduced to a business that turns out to be unsuccessful. The biggest and most common difference between those that are successful and those that are not, is having organised finances. All successful businesses prepare good books and records, usually with some form of management accounts. A plan or budget will often be in place, allowing the actual results to be compared. All of this should be done from day one, and will quickly become second nature. Such record keeping and comparison need not be difficult or onerous, certainly not compared to the other vital business activities of marketing and supplying your goods or services. A very simple system can be used allowing all of the financial transactions to be recorded, summarised and compared in one place. In business there is no requirement for complexity or to learn endless jargon. There is a requirement to understand you financial results and position and make better decisions by taking account of these.
Consultants and Contractors
Many individuals in certain industries such as IT or the oil industry obtain their work through agencies. These agencies often require the contractor or consultant to operate through a limited company, as opposed to operating as a sole trader. The usual advantages of a limited company may not be a large factor, but there will be little disadvantage and therefore this is not a problem. Such businesses are often the focus of IR35 as outlined below.
IR35
The IR35 rule is aimed at people who would be employees, except they have created a "business" by trading as a limited company. If you have only one customer at a time, and potentially for long periods, then IR35 must be considered. It can apply to any occupation or profession, the classic example is the "consultant" who advises just one "client". The problem is that this relationship may be that of "employee" and "employer". By placing a limited company between the individual and the end user it was possible to treat this relationship as a business, thus obtaining more favourable tax treatment of expenditure and potentially generating the tax and national insurance savings of incorporation referred to above. IR35 now prevents such savings applying if the relationship would have been one of employee and employer were it not for the limited company. Thus, if no employment relationship would have existed anyway then IR35 does not apply. The test of employment as opposed to self employment is based on a number of criteria which are assed and the relationship reviewed as a whole. The overriding theme is one of control. If the worker can control the methods, hours, place, details and who performs the task and if they are responsible for correcting defective work, taking out insurance and can take on more than project at once, then they are probably not an employee. In other words IR35 will not be a problem to them. If you do not have control of all of these factors, or are unsure if IR35 applies to you then professional advice should be obtained from specialists such as SJD Accountancy.
Most important advice
"Many successful business owners are self motivated and head-strong; all successful business owners take good advice". If you want advice on any aspect of business then talk to us at SJD Accountancy. No matter what walk of life you think of, the quickest and most sure fire route to success is to talk to and be guided by people with experience of actually succeeding. Accountancy Age Excellence Awards National Winners SJD Accountancy have succeeded both in advising their clients businesses and in carrying out their own. And whoever you take advice from, make sure you know the guaranteed fixed fee in advance. Only allow professionals to charge a fee amount that you have specifically agreed to. Allowing fees to be calculated after the work is done is equivalent to handing over a blank cheque. For a fixed fee quotation on for all of your accounting requirements contact the author of this article at louise.bowman@sjdaccountancy.com or telephone 01442 275789.
