Startups in the real world - Choosing a company structure

Andrew Dancy
Posted by Andrew Dancy
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Andrew Dancy by Andrew Dancy

If you're just starting to get involved in the startup world, or you are thinking of doing so, it can be quite daunting when you see some of the formalities or "red tape" that can be involved.

This is the first of a number of articles which will concentrate on some of the practicalities of running a startup business. Topics that will be covered include getting your business up and running, what to do when you need to hire your first employee, top tips and things to avoid and anything else that comes to mind!

Please bear in mind that any advice in these articles is subjective and based on personal experience. It is not legal or financial advice and should not be relied on without confirmation from an expert! Having said that, all advice is based on the real-world experience of the Reincubate team, having worked with businesses of all sizes from one-man startups to FTSE 100 global corporations.

So, without further ado, let's get onto the first topic. You've come up with a brilliant idea and you're ready to get cracking with it. The first thing you'll need to do is establish a legal entity for your business.

Here in the UK there are two main ways you can do this - on a self-employed basis or as a limited company. Other business types (such as partnerships) do exist but they are not usually relevant.

Self Employment

The self-employed route is often the simplest way to start for the lone entrepreneur. The only formal requirement is to notify HMRC that you have started a period of self-employment and then to keep sufficient records to allow you to fill in the Self Employment portion of your tax return at the end of each tax year.

You don't actually need to have a separate bank account (although it is a very good idea to keep the business financial separate from your personal finances) and you can keep records in any way you like, so long as they are accurate enough to be able to work out total business income and expenditure at the end of each tax year.

The main downside of the self-employed route is that there is unlimited personal liability for any business dealings. In other words, any debts or legal issues with the business can be pursued against you the individual. Moreover, because there is no formal structure for a self-employed business it is not possible to hire staff (although you can of course use contractors or freelancers).

For this reason, pretty much all startups will need to incorporate as a limited company at some point, and therefore many choose to start as a limited company from the beginning to save the hassle of having to switch from being self-employed to being a limited company.

Limited Company

A limited company is a company that is limited by means of shares. This means that the limited company is a distinct legal entity owned by the shareholders in the company. Each shareholder has 'limited liability' in that they cannot be exposed to debts or risk greater than the value of the shares they hold in the company - their personal assets are not generally at risk (with an important exception in the case of fraud or other criminal activity!)

Establishing a limited company is a bit more complex than registering for self-employment, as there are a number of decisions that have to be made in terms of how the shares in the company will be structured and the rules and regulations that will govern how the company is run (known as the company 'articles').

Moreover, once a company is up and running there are various ongoing requirements to keep proper accounting records, draw up annual accounts each year, file annual company returns, to work out and pay corporation tax if the company makes a profit and so forth.

However these are not particularly onerous requirements if the proper procedures and processes are put in place from the beginning. Some companies also choose to outsource a lot of these requirements to their accountants or their lawyers, although this can be expensive.

Which is best for me?

In general I would say that 9 times out of 10 the best route for a startup would be the limited company option. The only scenario where self employment may make sense is if it is clear that the business will only be on a very small scale for a number of years (perhaps if a sole founder is working on the startup in their spare time) and it would therefore not be cost-effective to establish and maintain a limited company.

Next time - how to set up a limited company.

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