Business structures – the risks of getting it wrong – part two

In our previous blog ‘Business structures – the risks of getting it wrong – part two‘, we explored a range of structures you could use to set up your business. These included sole traders where you could be your own boss, receive the profits but be personally responsible for all the trade’s losses. We also discussed partnerships, where two or more partners can agree to share profits and losses and again be personally liable for all such losses.

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In each case, there are upsides (such as the ability to run the business with comparatively low administration) but the downside of unlimited personal liability for the partners. We also covered Limited Liability Partnerships (LLPs), which are governed by statute, have the organisational flexibility of partnerships, a greater administrative burden but with limited personal liability for members.

The next structure we will explore is limited companies. These account for around a quarter of all UK businesses. They can either be publicly owned, as many of the large companies are, such as BT, Unilever or Diageo, or privately owned, as many family-run companies are (John Lewis, whilst referring to its stakeholders as partners, is in fact a limited company).

A limited company is a body corporate, which has a separate legal personality. This means that a company can hold its own assets and enter into contracts itself. It will be run by a separate board of directors and shares in the company will be owned by individuals or other entities (such as other companies, which are known as parent companies). These individuals are often also directors of the company. The administrative burden for limited companies is greater than for simpler structures such as sole traders, with regular filings required at Companies House.

The company will have its own constitution, comprising memorandum and articles of association (setting out the company’s objects and powers and the rules governing how the company will regulate such things as meetings and decision making).  It is essential that this reflects what the founders and members have agreed, to mitigate the risk of the company doing something outside of its powers and/or having difficulty functioning, in each case increasing litigation risk.

The liability of shareholders will be limited to the amount they have committed to share capital. There are instances where shareholders may have further liability, for example where personal guarantees for bank loans or tenancies are given. Directors also need to be careful not to incur personal liability for the company’s debts if it becomes insolvent. Proper advice should be taken before you potentially expose yourself to personal liability in these types of situations.

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. Companies can be owned by individuals, partnerships, LLPs or other companies both in the UK and overseas; company family trees can often be complex.

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. By not getting it right there is litigation risk that could otherwise have been avoided. If you do still find yourself in difficulty, taking advice early can help to mitigate that risk.

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If you would like advice on any of the issues mentioned in the blog, please contact BLM’s Commercial Litigation team here

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