You and your two best friends have decided to go into business together. Leaving aside the merits of mixing business with friendship, one of your first decisions will be how to structure that business: should you operate as a general partnership or should you form a limited company? Should you be partners in a firm or shareholders in a company?Understanding the key differences between these alternatives is vital to ensuring you make the right choice.
Know your limits
An important difference between a partnership and a company is that partners have unlimited personal liability for the debts and obligations of their partnership business. As a partner you will also be liable for any wrongful acts carried out by your fellow partners in the ordinary course of the partnership business. Trusting your fellow partners is therefore crucial.
A company, on the other hand, is a legal person separate from its shareholders. So it’s the company, not its shareholders, that is liable for the company’s debts and obligations. The liability of the company’s shareholders is limited to the amount (if any) unpaid on their shares. This can be relatively small if the shares have a low nominal value and no premium is payable for them. Be aware, however, that the benefit of limited liability is easily lost if the shareholders have to give personal guarantees for the company’s business.
Since a company is a separate legal person, it can enter into contracts and hold assets in its own name. With a partnership, however, there is no separate legal person besides the individual partners. Therefore, trading can become a little complicated as contracts must be entered into, and assets held, by individual partners in their own names as agent or trustee for the partnership.
Secrecy vs transparency
The internal operations of a partnership are known only to the partners. There is no requirement for a written partnership agreement (although this is a good idea) and even if such an agreement exists it is not publicly available. Similarly, the accounts of a partnership do not have to be audited or filed on any publicly available register.
For a company, however, its internal rules of governance – its articles of association – are available to anyone via Companies House. Any arrangements which shareholders wish to keep secret must be set out in a separate shareholders’ agreement. A company is required to produce accounts each year which must also be filed at Companies House for all to see.
The tax position
As a partnership is not a separate legal person, the partners simply pay tax on their share of the partnership profits but there is no tax payable by the partnership as such. For a company, however, there is a double-layer of taxation: the company pays corporation tax on its profits and the shareholders then pay income tax on any profits paid to them, either as remuneration or dividends. However, the rate of corporation tax is generally lower than that for personal income tax and dividends are also taxed at a lower rate.
A third way?
For those finding it difficult to choose between the relative pros and cons of a partnership and a company, there is a third way – a limited liability partnership (LLP) which combines some of the merits of each structure. Crucially, LLPs offer the organisational flexibility and tax transparency of a partnership with the limited liability of a company. Like a company, an LLP is a separate legal person and so is responsible for its own debts and obligations. The liability of its members is limited to their agreed contribution to the LLP, although they can also incur personal liability for wrongful or fraudulent trading and, in some circumstances, for negligence. Like a partnership, the LLP members are taxed on their share of the LLP’s profits with no tax being paid on those profits by the LLP itself.
Which is the right one for you?
A partnership is likely to favour a relatively small number of individuals setting up a business which will not incur significant debts or obligations where the risks associated with unlimited liability are low.
A company may be more appropriate where the benefits of limited liability outweigh the disadvantages of public scrutiny and where there may be changes in the participants in the business – this has less practical effect in a company than in a partnership or LLP.
An LLP offers a useful halfway-house for enterprises which will involve a number of individuals where debts and other liabilities may be significant so limited liability is important.
But remember, one size does NOT fit all and you should take specific advice on which is the right structure for you.
For more information email firstname.lastname@example.org.