Business Formation

Business Structures

Business Structures

When starting a new venture you will need to consider what the best operating vehicle is most suited for you. There will be numerous options available. You can choose to operate as a sole trader, you can form a limited company, a partnership or a limited liability partnership. Whilst there are several other forms of business structures available, these will be the most appropriate when setting up a law firm.

When considering the best vehicle for your business you will normally need to consider the following:

  • Registration process;
  • Personal Liability;
  • Tax advantages and disadvantages;
  • Investment Opportunities; 
  • Growth and Recruitment;
  • Exit and associated tax.
Sole Trader

Operating as a sole trader may seem like an attractive option if you intend to be the only person involved in the running of the business. You will be required to register with HMCR as a sole trader and will need to file your personal Self Assessment Tax Return every year, pay income tax and pay National Insurance to HMRC. This is fairly easy to do and you do not normally need to engage an accountant unless you operate in an industry which has this requirement. If you decide to trade as a sole trader there will be minimal levels of bureaucracy involved. 

The major disadvantage is that as a sole trader you will be personally and fully responsible for the debts and liabilities of your business and this does put your personal finances at risk. You may also find that by operating as a sole trader your business lacks credibility when dealing with third parties. If you are hoping to secure external investment then this is virtually impossible as a sole trader. Another downfall is that you  will not be able to recruit someone to assist you with your business and so this may restrict your business growth.

You will be able to sell the assets of your business if you decide to exit the business, but goodwill will normally be minimal. This is because if you trade as a sole trader, the goodwill will be associated with you personally and may not attract huge returns if you do not remain a part of the business following the sale.


A Partnership involves two or more individuals that agree to share in the profits or losses of the business.  In the absence of a partnership agreement, the profits or losses from a partnership will be shared between the partners equally. This can be varied by a partnership agreement and the profit can be shared at an agreed ratio. Certain partners may also provide indemnity against losses to more junior partners, however it is important to remember that the indemnity is as good as the person giving it.

Partnerships are referred to as unincorporated entities in that the partners are self employed. They are personally responsible for the losses or debts that the business undertakes. Each partner is also responsible or liable (jointly and severally) for other partner’s negligence or misconduct. As partners are self employed, each partner will need to register with HMRC as a sole trader, file their personal Self Assessment Tax Return every year, pay income tax on their share of the partnership’s profits and pay National Insurance to HMRC. There will be no public record of the profits or the losses as you will not be required to file the returns with the Companies House.

If you are a partnership you will be able to recruit someone to assist you with your business. A partnership is not a separate legal entity so any recruitment activity will be carried out by the partners who will be the ultimate employers. The major disadvantage is that if you operate a partnership, all the partners will be personally and jointly or severally liable for the debts and liabilities of the partnership and this does put your personal finances at risk.

If there is no partnership agreement a partner cannot retire or leave the partnership so the partnership has to be dissolved. One partner can dissolve the partnership simply by giving notice to the other partners.  Partnerships which do not have a partnership agreement are also automatically dissolved on the death or bankruptcy of one of the partners. If there is a partnership agreement then it is possible for the partnership to continue when one partner exits the partnership and the provisions of such exit will be contained in the partnership agreement. The assets of the partnership can also be sold.

Limited Liability Partnership

An LLP has similarities to both the partnership and the limited liability company. Partner’s liability is limited to the amount of money they invest in the business. An LLP can be incorporated with 2 or more members and a member can be an individual or a company. An LLP must be registered at Companies House and with HMRC. Annual accounts will have to be prepared and filed and such information will be part of public record. Members’ responsibilities and share of the profits will normally be set out in the LLP agreement and all members must submit a personal Self Assessment Tax Return every year, pay income tax on their share of the partnership’s profits and pay National Insurance to HMRC.

The main drawback of a partnership is that in an LLP ownership and management are very closely linked. For this reason LLPs are quite difficult to invest in and it is difficult to incentivise staff with a share of ownership. The assets of the LLP can be sold but the provisions of such sale will normally be set out in the LLP agreement. It is usual for it to require the exiting partner to sell his or her shares to the remaining partners. If there are only two partners in the LLP, this may be impossible as the LLP cannot have less than two partners.

Limited Liability Company

Although traditionally, law firms preferred to operate as Partnerships and more recently as Limited Liability Partnerships, there is an increase of law firms choosing to operate under Limited Liability Company. It may be due to the increased appetite of investment in the legal industry and the need for firms to find new ways to incentivise the workforce which usually involves offering employees some share options. 

A Limited Liability Company (LTD) is owned by its shareholders and run by its directors. The company is a separate legal entity with its own legal rights and obligations. This means the company is responsible for everything it does and its finances are separate to the personal affairs of its owners. Most limited companies are limited by shares which means the shareholders responsibilities for the company’s financial liabilities are limited to the amount that the shareholder has agreed to pay for the shares.

The LTD will need to be registered with the Companies House before it is able to trade and will be required to file its accounts with Companies House and HMRC and pay Corporation Tax on any profits generated. The shareholders of the company will then be able to distribute profits in accordance with their shareholding in the form of dividends. Shareholders are required to file Personal Self Assessment Tax returns with HMRC and pay income taxes on dividends received. If shareholders are also directors, they may also choose to receive a salary which will be taxed under the PAYE. If you are a shareholder and a director, you can decide on remuneration packages at your discretion. For example if you have a shareholder who does not play a role in running and managing the business, you may choose to pay salary to those who are directors under the director’s service agreement. Any such payment will be treated as company expense. The remaining profits can be split in accordance with the shareholding allowing those who actively work in the business to be fairly rewarded for their contribution.

You can sell the shares of the LTD or you can sell your business by way of an asset sale. It is also easier to get third party investment or raise debt finance, however normally as a start up you may be expected to give personal guarantee for any such debt.

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