commercial law

Business Formation

The main types of business organisation in the private sector in the UK are:

1. sole traders
2. partnerships
3. companies
4. franchises

The sole trader

The sole trader is the most common form of business ownership. It is used for a wide range of businesses, such as plumbing, decorating and small retail shops.

As a sole trader, you run your own business and are classed as “self-employed”. Despite the title you are able to employ staff. You are responsible for the business; you do not have to work alone.

The advantages of a sole trader business include:

• it is relatively straightforward to set up the business
• you can keep all your business’ profits after you’ve paid tax on them
• decisions can be made quickly
• you can have close contact with your customers and employees
• you have the satisfaction of building up your own business.

There are also disadvantages. As a sole trader you:

• may have to make all the decisions yourself without the support of other partners or managers
• may have to work long hours and you might have no-one to take over from you when ill or you want to take a holiday
• you are personally responsible for your business debts - there is no limited liability
• you have to provide all the finance yourself
• may not have all the skills required to run a successful business

Setting up as a sole trader

Sole traders must register with HM Revenue & Customs (HMRC) and follow certain rules on running and naming their business.

You must register for Self Assessment with HMRC after starting your business. This must be done as soon as possible.

You are responsible for:

• your business debts
• bills for anything you buy for your business, such as stock or equipment
• keeping records of your business’ sales and expenses
• sending a Self Assessment tax return every year
• paying Income Tax on the profits your business makes and National Insurance
• and you may need to register for VAT if your buisness has a turnover above the VAT threshold

You can choose to do business under your own name or trade under a business name.

There are rules on using a business name. For example, you can’t:

• use the terms ‘Limited’, ‘Ltd’, ‘public limited company’, ‘plc’, ‘limited liability partnership’, ‘LLP’ or their Welsh equivalents
• use certain specific ‘sensitive words or expressions’ unless you have permission from the Secretary for State
• suggest a connection with government or local authorities
• use a name too similar to a registered trademark or an existing business in the same area or sector
• be offensive

You must include your own name and business name (if using one) on any official paperwork, such as invoices and letters.

The partnership

An ordinary partnership can have between two and twenty partners.

However, the Partnership Act of 2002 made it legal for some forms of partnership to have more partners who also enjoy limited liability.

People in business partnerships can share skills and the workload, and it may be easier to raise the capital needed.

Partnerships are particularly common in professional services e.g. accountants, solicitors, vets and doctors.

For example, a group of doctors can pool their medical knowledge. Two or three doctors working together may be able to operate a 24 hour surgery. When one of the doctors is ill or goes on holiday, the business can still operate.

Setting up a partnership

Partnerships are usually set up by completing a deed of partnership. Prepared by a solicitor, the document sets out important details such as how the profits and losses will be shared.

The business partnership as a collective and each individual partner must register for Self Assessment with HM Revenue & Customs (HMRC) and follow certain rules on running and naming the business partnership. These rules are different than those for limited liability partnerships and limited partnerships.

A ‘nominated partner’ must be chosen - the partner responsible for managing the partnership’s tax returns and keeping business records.

The nominated partner registers the partnership for Self Assessment. All individual partners (including the nominated partner) register separately; usually after the partnership is registered.

In a business partnership, you are running a business as self-employed individuals with each partners sharing responsibility for the business. You can share all the profits between the partners in the way you agree and each partner pays tax on their share of the profits.

Both the nominated partner and individual partners are responsible for:

• sending personal Self Assessment tax return every year
• paying Income Tax on their share of the partnership’s profits
• paying National Insurance
• any losses the business makes
• bills for the business - e.g. when buying stock or equipment
• registration for VAT (if necessary)

The nominated partner must also send the partnership’s tax return.

You can use your own names or trade under a business name. There are rules on using a business name, you can’t:

• use the terms ‘Limited’, ‘Ltd’, ‘public limited company’, ‘plc’, ‘limited liability partnership’, ‘LLP’ or their Welsh equivalents
• use ‘sensitive’ words or expressions unless you have permission from the Secretary for State
• suggest a connection with government or local authorities
• use a name too similar to a registered trademark or an existing business in the same area or sector
• be offensive

You usually have to include all the partner’s names as well as your business name (if you have one) on any official paperwork, such as invoices and letters.

Companies

A company is a legal body in its own right with an existence that is separate in law from its owners. The company can be sued and can sue in its own name.

Shareholders put funds into the company by buying shares.

There are different types of companies.

Private Companies

Private companies have Ltd after their name. They are typically smaller than public companies although some are very large.

The Private Limited Company is owned by the shareholders. They appoint Directors to give direction to the business.

Private Limited Companies can have as little as one director and one shareholder and operate small businesses which would otherwise operate as a “sole trader”.

Larger Private Limited Companies will appoint a Chief Executive. This senior official is given responsibility for making major decisions. Specialist managers will be appointed to run the larger companies on behalf of the Board.

Shares in a Private Company can only be bought and sold with permission of the Board of Directors.

Shareholders have limited liability provided they comply with the law, whereas sole traders are personally responsible for their business debts. The shareholder’s liability depends on the type of company created:

• A Private Company limited by shares means the shareholders’ liability is limited to the original value of the shares issued
• A Private Company limited by guarantee means the company members financially back the company up to a specific amount if things go wrong, which is normally set at a nominal £1.

Setting up a private limited company

Setting up a Private Limited Company is more complicated than setting up as a Sole Trader or Partnership.

a) Register with Companies House

To set up a Private Limited Company you must register (or ‘incorporate’) the company with Companies House.

Once the company is registered you’ll get a ‘Certificate of Incorporation’. This confirms the company legally exists and shows its company number and date of formation.

To register the company with Companies House you will need:

• the company’s name and registered address
• at least one director
• at least one shareholder
• details of the company’s shares - known as ‘memorandum of association’
• rules about how the company is run - known as ‘articles of association’

You can register:

• online if the company is limited by shares and uses model articles of association
• by post using a prescribed form - you must do this if you do not wish to use the model articles
• using an approved agent as listed on the company house website

Online registration takes 48 hours and costs £15. Postal applications take 8 to 10 days and cost £40. The cost of a company agent will typically be about £120.

b) The Company Name and Address

The names of all Private Limited Companies in the UK must end in either ‘Limited’ or ‘Ltd’ and the name can’t:

• be the same as any other name on the Companies House index of names
• contain a ‘sensitive’ word or expression unless you get permission
• suggest a connection with government or local authorities
• be offensive

The registered office address is where official communications are sent - e.g. letters from Companies House and HM Revenue & Customs. The address doesn’t have to be where you operate your business from but it must be:

• a physical address
• in the same country that your company is registered in - e.g. a company registered in England must have a registered address in England

You can use a PO Box, but must also include a physical address and postcode. You can use your home address or the address of the person who will manage your Corporation Tax if these addresses meet the rules above.

c) Directors and Company Secretaries

When registering your company it must have at least one director.

A director is legally responsible for running the company. They must be older than 16 and not disqualified from being a director.

You can make another company a director - but at least one of your company’s directors must be an individual.

Directors have responsibilities that include making sure the company is run properly. A director’s interests must not conflict with the interests of the company.

You don’t need a company secretary for a Private Limited Company. Some companies use them to take on some of the administrative responsibilities.

The company secretary can be a director but can’t be:

• the company’s auditor
• an ‘undischarged bankrupt’ - unless they have permission from the court

The restrictions placed on a person when they’re made bankrupt usually end when they’re discharged. You can check if someone has been discharged by using the Insolvency Register.

Even if you have a company secretary, the directors remain legally responsible for the company.

d) Statement of Capital

When you register a company you’ll need to make a ‘statement of capital’.

This is:

• The number of shares the company has and their total value - known as the company’s ‘share capital’. For example, a company that issues 500 shares at £1 each has a share capital of £500
• The names and addresses of all shareholders - known as ‘subscribers’ or ‘members’

e) Shareholders

Every limited company must have at least one shareholder, with no maximum number. Directors can also be shareholders.

Shareholders are owners of the company and have certain rights, e.g. to agree to changes to the company, to fix the remuneration of the Directors and to decide on any dividends.

f) Articles of association

When you register your company you must have articles of association.

These are the rules about running the company that shareholders and ‘officers’ (directors or a company secretary) must agree to. For example, rules about how decisions affecting the company must be made and the role of shareholders in those decisions.

Most companies use standard (‘model’) articles - but you can change these or write your own as long as they cover all relevant issues.

g) Corporation Tax

Within 3 months of starting up in business, you must give HM Revenue & Customs (HMRC) specific information about your company. You can do this once you’ve received your company’s Unique Taxpayer Reference.

HMRC will use this information to work out when your company has to pay Corporation Tax.

You must tell HMRC:

• the date you started in business
• your company name and registered number
• the main address where you do business from
• what kind of business you do
• the date you’ll make your annual accounts up to
• if you’ve taken over a business or you’re part of a group

Any business activity counts as starting up, e.g. buying, selling, employing someone, advertising or renting a property.

h) Unique Taxpayer Reference

HMRC will send your company’s Unique Taxpayer Reference to your registered office address, usually within a few days of the company being registered (incorporated).

The letter tells you how to:

• give HMRC the information they need about your company
• set up your company’s HMRC online account for Company Tax Returns and Corporation Tax

Public Companies

A Public Company can sell shares to the public and to financial institutions and have their shares traded on the Stock Exchange.

The main advantage of this is large amounts of capital can be raised very quickly.

One disadvantage is that control of a business can be lost by the original shareholders with control over who buys shares outside their control.

In order to create a public company the directors must apply to the Stock Exchange Council, which will carefully check the accounts. The cost of becoming a public company is very substantial. Companies would normally convert from private to public after many years of successful trading.

Franchising

Franchising is becoming increasingly popular in the UK. Examples of well-known franchise business models include McDonalds and Subway.

Franchising is really the 'hiring out' or licensing of the use of 'good ideas' from a Franchisor to a smaller trading company (the Franchisee). A franchise grants permission to sell a product and trade under a certain name in a particular area.

To invest in a franchise, the franchisee usually has to pay an initial fee for the rights to the business, training, and the equipment required by that particular franchise.

Thereafter, the franchisee will generally pay the franchise business owner an ongoing royalty payment, either on a monthly or quarterly basis. This payment is usually calculated as a percentage of the franchise operation’s gross sales.

Franchise agreements

The franchise agreement is key to the franchisee-franchisor relationship. It is this document that is legally binding on both parties, laying out the rights and obligations of each.

You should have it reviewed by a solicitor with experience of franchise matters as the agreements are often one-sided in favour of the franchisor.

There is no standard form of franchise agreement because the terms, conditions, and methods of operations of various franchises vary widely depending on the type of business involved.

The agreement may stipulate that the franchisee must buy an agreed percentage of supplies from the franchisor, who thus make a profit on these supplies as well as controlling the quality of the final product. The franchisor often takes a percentage of the sales of the business, without having to risk capital or become involved in the day-to-day management.

While there are many benefits to investing in an already successful franchise business model, there are drawbacks too.

The franchisee will not have as much control over the business as he or she would over their own business. They will usually have little influence on the business model and be required to use the uniforms, business methods, pricing and signs or logos particular to the franchise business.

The franchisee may benefit from trading under a well-known name and enjoy a local monopoly. Training is usually arranged by the franchisor and the franchisee is his or her own boss and takes most of the profits.

As with any investment you make, you should do your research thoroughly before you make any franchise purchasing decisions. If you are considering buying into a franchise, please contact us for further assistance.

Let us help

If you are starting a business as a sole trader, partnership or limited company or are thinking about making your existing business into a limited company please contact us for further advice or assistance.

Please ask for Paul Hughes on 0121 705 7571
or email paulhughes@wallacerobinson.co.uk

Further reading:

Management buy outs and buy ins (Commercial Law)

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