(Including Advantages & Disadvantages)
By Gaia Freydefont
There are many different types of corporate structures, and they can be either incorporated or unincorporated. The major distinction between these categories is that incorporated entities have a separate and distinct legal personality, unlike the unincorporated forms.
Most relevant to entrepreneurs and startups are the following three major corporate structures: sole traders, limited liability partnerships and private companies limited by shares.
Sole traders: A sole trader is an individual who offers goods and services in return for payment. As a sole trader, there is no distinction between your identity and that of the business you have registered. A sole trader will at every point in time be personally liable and responsible for any losses the business may experience. At the same time, you will be the sole beneficiary of all the profits.
Some advantages of a sole trader structure include, the simplicity of its business structure, the fewer statutory obligations required to set up, the lower costs and profit retention, the privacy and its flexibility.
However, sole trader structures also come with some disadvantages, including the fact that a sole trader will have unlimited personal liability, limited access to finance due to a potential lack of transparency, inability to IPO or to list on the stock exchange and fewer tax planning opportunities.
Limited Liability Partnership (LLP): LLPs are corporate entities with a legal personality. LLP’s can be thought of as a hybrid between a company and a partnership. Once an LLP is set up, it obtains independent legal status and offers limited liability to its members. The limit of each partner’s liability is agreed upfront and set out in an agreement between the partners.
Since LLP’s are closer to companies in nature and structure, this structure particularly supports financing and is a valuable alternative to setting up a company for certain businesses such as law firms and accounting firms for example.
LLPs do not have shares and the partners do not have any obligation to contribute capital. For tax purposes, the LLP partners are treated like ordinary partnerships, meaning each partner remains liable for their own taxes and their profit of their businesses.
LLP’s have the advantages of allowing its members to enjoy limited liability, have a separate legal personality, having flexibility and privacy.
Some disadvantages include the availability of fewer tax planning opportunities, potentially limited access to finance from investors and the inability to IPO or list on the stock exchange.
Private company limited by shares:
A limited liability company can either be limited by shares or limited by guarantee. When a company is limited by shares, this means that the company has a share capital and is owned by shareholders. An incorporated entity with a separate and distinct legal personality is a company. The amount paid by the shareholders for shares held by them constitutes the capital used to run the business.
When issuing shares, there are different classes that we can categorise as class A shares, class B shares and class C shares. This generally means you can give different rights to different shareholders.
For example, you can give a class A shareholder the right to vote on certain matters that a class B shareholder doesn’t have the right to vote on.
Private companies limited by shares have several advantages such as its being a separate legal entity to its owners, meaning the owners can enjoy limited liability, implying less risk, additional sources of finance, prestige allowing for transparency, order and professionalism, flexibility, higher transferability of shares and the ability to reduce your tax liability.
On the other hand, in cases where a start-up doesn’t have enough bank assets to secure a loan, personal guarantee may be required by the bank.
Therefore, access to small business funding is increasingly expected to depend on signing a personal guarantee, potentially putting the business owner’s personal assets on the line, despite setting up a private company limited by shares.
However, setting up personal guarantee insurance can help mitigate this risk. Setting up a private company limited by shares involves many statutory obligations as it is a complicated form of a structure, less privacy, higher accountancy costs and more complex administration as directors need to record information on a monthly basis.
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