Business Structures - The Risks of Getting it Wrong - Part One
Welcome to the first in a series of blogs prepared by BLM’s Commercial Litigation team that will take you through the life cycle of a company from the beginning until the end. Each blog will focus at a different stage such as forming a business and the different options available, making an impact in the business world to potentially getting ‘divorced’ in a partnership and parting ways. Our experts’ advice and knowledge will help guide you to understand and deal with litigation risks.
You’ve finally got your plan together and a trading name and are ready to join the business world.
But how are you going to set up? Getting the right structure for your business is essential to building a solid and workable foundation for that business going forward.
If you want to set up as a sole trader, for example “Amy Smith trading as The Widget Fixer”, then whilst you will be one of millions of such businesses in the UK, you will be on your own. That means that you run the business, make your own decisions and own all the assets. It is an informal structure, requiring a comparatively low amount of administration. It can suit one person that wants to be their own boss and employ others if they choose which can be a good fit for a budding entrepreneur or someone who wants a lifestyle business.
The downside for sole traders is that the buck stops with them. A sole trader has no legal personality separate from its owner. If a successful claim is made against this type of business and it is not covered by insurance, then the owner’s liability is unlimited and their personal assets will be on the line. Losing a dispute can therefore have serious consequences, so you need to manage this risk from an early stage of that dispute.
Amy Smith and Oliver Jenkins who are like-minded business people may instead think about setting up as a partnership, “The Widget Fixer”. Partnerships are formal relationships between at least two people carrying on a business in common with a view to profit. The statute governing partnerships goes back to the 19th century. Usually partners will enter into a joint agreement that deals with shares of profits and losses and what to do if a partner joins or leaves. Without an agreement or some clear evidence, it will be assumed that partners share profits and losses equally. Again, there is a comparatively low amount of administration and the partnership’s results do not need to be made public. These have been traditionally popular with business like doctor’s surgeries and other professional practices.
A disadvantage is that a partnership also does not have a separate legal personality. This means that if a successful claim is made against the partnership, the partners’ liability will be unlimited and their personal assets will be at risk of being disposed of to satisfy creditors. It is vital that everything is properly set up, so there are no disputes over how the partnership makes its decisions, shares profits or, equally importantly, losses.
Limited liability partnerships
Partnerships should be contrasted with Limited Liability Partnerships (LLPs). LLPs are governed by statute and have the organisational flexibility of partnerships. Amy and Oliver could therefore set up as “The Widget Fixer LLP”. LLPs do have a separate legal personality, which means that the LLP owns the assets and the partners run the business but now have limited liability based upon the amounts they have committed as capital. This is subject to any separate arrangements between the partners.
LLPs do have to register with Companies House and publish their results, so the administrative burden is greater. If you don’t get the division of assets, drawings and liabilities properly drawn, and decision making and direction of the LLP clear, you could be heading for a ruinous dispute. If you can, and have a dispute resolution structure in place, then the litigation risk is reduced.
It should be stressed that nothing is for ever and business structures do change, so that a sole trader can decide to go into partnership with others and then to convert to an LLP or another entity, like a limited company, or the reverse.
Limited companies account for around a quarter of all UK businesses; we will look at these and other structures in more detail next time.
Above all, if you are planning to set up as a business, make sure you take proper advice, including tax advice, and that the structure you choose works for you. It can be costly if you start off on the wrong foot. Look for the things that could go wrong right at the outset, get a mechanism in place for dealing with them and you should make a tough situation easier.
If you would like advice on any of the issues mentioned in the blog, please contact BLM’s Commercial Litigation team here.