Should I Form a Company?
A guide to Incorporation for Small Businesses by Alastair Young, Trainee Solicitor
Many small business owners wonder whether it would benefit them to form a limited company or whether it is better for their business to remain as a sole trader or partnership.
Often the legal and financial jargon can seem baffling and the consequences don’t always seem clear. The fact that incorporation is governed by the Companies Act 2006, the longest piece of legislation ever produced by Parliament, can make the idea of creating a company seem like more trouble than it’s worth. While incorporation isn’t for everyone it can bring a lot of benefits, some of which I will outline below.
Many people decide to incorporate because it limits their personal liability. Before forming a company, sole traders and partnerships are completely responsible for any debts and liabilities their business incurs.
An incorporated company has its own legal personality and as such, employs its own staff, enters its own agreements and incurs its own debts. Shareholders are only liable for the amount unpaid on any shares they buy but as most shares are paid up in advance, company owners are generally more able to walk away if things go wrong.
Incorporation brings a wider range of options for raising finance than a sole trader or a partnership has. If a sole trader needs a cash injection to kick-start, grow or rescue their business they are limited to borrowing money, either from friends and family or a bank loan.
Limited companies can create ‘floating charges’ over the assets of the business, this is a special type of security given to the lender which allows them to recover the debt from non-permanent assets such as stock, work in progress or cash. Companies also have other ways to raise finance, including selling shares in the business which allows them to raise capital without borrowing money. There are also a range of other options not open to partnerships and sole traders.
With partnerships and sole traders the organisation within the business can become muddled. Often there is no defined structure that separates out the departments, regulates internal and external relations and ensures continuous review and management of affairs. An enterprise where roles are not clearly defined can create tensions which could risk the whole business if uncorrected.
An incorporated business has an inbuilt structure which is flexible enough to adapt to the market yet solid enough not to be ignored. A good example of this is the distinction between the owners (shareholders) and managers (directors) although these can be the same people.
A company can also create subsidiary companies to further limit financial exposure and delegate parts of the business to different sub-companies. This is particularly important for those looking to grow their business into a large company.
Incorporation isn’t right for every business, it is important to consider initial and ongoing costs, management, filing annual accounts and whether incorporation coincides with the size, financial position and objectives of the business. There are other ways to structure a business without forming a company. Above all, we recommend consulting a commercial solicitor to discuss what is best for your businesses needs.