Business Entities
The modern world is built on perceptions; our own, our customers', the public's. There is perhaps no more important perception than the tax man's. When going into business for yourself, choose your business entity wisely.
What are the options?
Sole Trader
Perhaps the simplest.
Your personal finance is tied to liability- if a contract falls through or the business goes into debt, you are expected to pay for it. Hence public liability and professional indemnity insurance become very important, as expensive contracts become expensive risks if you fail to deliver on them as promised.
Income tax is calculated from your own profit, which you declare in April when you fill out your self assessment tax return for that year. ( The deadline for an online tax return is 31st January the next calendar year, but best to get it out the way early.)
You are unlikely to be taxed more than a hundred or so in the first year, unless you really hit the ground running with your business. The personal tax threshold in the UK currently stands at £12,570.
That said, if you earn above that amount, you can reduce your tax bill with legitimate expenditure
You are taxed on your profits, and if you claim expenses, these are taken from your overall profits, and therefore your overall tax.
Examples of tax deductible expenses include
Travel to and from business locations, be that public transport or petrol . It is currently 45p per mile for the first 10,000 miles 25p per mile for anything over 10,000 miles. (Sadly this does not cover the commute from home to the office/ Stiwdio, but it does cover travel to an external filming site or to meet a client)
Overnight stays on business excursions
Heating, lighting and maintenance of premises. ( Obviously not a problem if you are based at the Stiwdio incubator, as all of this is free anyway, but worth bearing in mind for future, if you expand into your own office space.)
If you employ others in your company, you can also log the cost of their training, childcare or National insurance contributions as tax deductible.
Partnership.
Very similar to sole trader.
A partnership is essentially two sole traders, usually with one business bank account.
As such, each must fill in their own self assessment, and one partnership tax return between them
One person will act as 'nominated partner', they are expected to manage the partnership’s tax returns and are responsible for keeping business records.
If you cannot find a human to partner with, a limited company can also be a partner. Afterall, an LLC is a legal entity.
Limited Liability company ( LLC)
As part of an LLC, you still submit a self assessment tax return based on your own profits:
Your profits are calculated by the company’s profits and what percentage of shares you have in the company ( your dividends)
The company pays corporation tax on its profits ( currently 19%)
So if your LLC makes £20,000 in one financial year, it will pay £3800 corperation tax.
Say you have 60% shares, your 60% of the remaining £16,200 is 9,720, meaning you are below the personal tax threshold.
You pay income tax on your dividends, but this is at a lower rate to regular income tax
Again, legitimate expenditure can reduce tax.
You can also spend company time and resources in research and development to claim tax credits.
-HMRC is only interested in technological advances ( they might lead to social impacts, but these are not seen as the root-cause and as such cannot be logged for credits)
-For example-
Working out new methods of software integration
And
Smoothing out software bugs are both examples of technical R and D.
The actions that you can claim as tax relief would be:
Testing the new software/ processes
Outsourcing the development/ testing
-Technological advancement with tangible invoiced costs or staff are eligible. Profit making companies can claim 230% tax back once a year on research
In order to set up a LLC, you must register with Companies house- a fee of £12 to do so online.
Despite the added faff of deciding on the number of shares ( 100 or 10,000?) and corporate tax before you can even get your dividends, there are some bonuses
As the name implies, you are less liable for failure.
If the company goes bankrupt or insolvent, you only lose what you have invested, you are not expected to pay its debts.
How many shares are too many shares?
If you ever want to float your company on the stock exchange, you are going to need a lot of shares.
10,000 would mean that a share would be a relatively low risk investment, while angel investors with a lot of faith in your company could buy a bigger chunk- say 100, and still only have 1% of your company. You want to have the majority share ( over 50%, so in this example, more than 5,000 shares) so that you are allowed to make controlling decisions.
It is the majority shareholder who is expected to apply for loans in the company name.
If you apply for a loan that you cannot pay back, you face debt- this is then a position of responsibility.
As the majority shareholder makes the controlling decisions and can buy other shareholders out, it makes sense that this increased power is reflected in increased responsibility.
You may choose to offer shares as payment, particularly when you are just starting out, and do not have much capital to offer. You want to have enough shares for this to be possible, but not a ridiculous amount. If a startup was split into a million shares, one share would be rendered practically worthless, and you can’t barter with that.
More complicated options
So they are the big three, but if you want to delve deeper into business entities, there are also
Limited Partnerships
Again, you must register with Companies House.
Contains two types of partner-
The limited partner
The general partner
The limited partner can only lose what they put in if the company goes bust
As a result, they cannot make controlling decisions about the company
They cannot remove their contributions once they have been put into the company
The general partner
Is financially liable for any bills the business can’t pay
As a result, they have a lot more power.
They can manage the business.
They can make controlling decisions.
They can apply for the business to act as an authorized contractual scheme.
Community interest company
CICs
Not a charity, but not run for the benefit of shareholders either.
Although, confusingly, it can still have the structure of a limited company, with a director, a board and shareholders.
The CIC Regulator is an external board that keeps a close eye to ensure the company is working to meet its stated social goals, as opposed to simply operating for profit.
Given it’s purpose, it is open to certain community grants and funds
It can be limited by shares or guarantee ( in this case guarantee that it will work towards a stated goal)
If the CIC is dissolved, creditors must be paid and any other capital must be given to another CIC or charity to ensure that the good work continues ( the guarantee never dies.)
Instead of being paid in relation to the company’s profits and your shares, you set yourself a fair wage from the annual profits and will pay income tax on that .
B-Corps
A muddy middle ground.
Not bound by guarantee like a CIC, these are limited companies that apply for B-Corp status
To achieve B-Corp status, they must score at least 80 out of 200 in the B-Corp survey and pass a telephone interview with B-Lab.
This opens new marketing areas, as there is a great deal of consumer goodwill attached to companies with a positive impact on society.
It is certainly something to aim towards when formulating your startup plan.
Same as LLCs, you pay income tax based on company profits and your shares.
There are others, but these are the main players.
And there we have it.
Whether you decide to make your business a solo operation, or share it amongst contributors, there are a number of options to consider.
One of the many perks of registering for a desk, in person or virtual, at the USW Startup Stiwdio is the 1 to 1 mentoring and the weekly entrepreneurship boot camps that can help you with this decision.
What's more, it's free support for USW graduates
Drop your business idea here and apply for a space in the Cardiff, Newport or Treforest incubators today.