Small businesses are on the rise, but before you dive into something like coming up with a name or logo, we have an essential question for you: how will your business be structured from a legal standpoint? While it may not be the most exciting step, it determines everything from how you pay tax to how much personal risk you are willing to take.

One of the more common routes is partnerships and limited companies. A partnership is essentially when a few people each run part of a business, and they all share the work. A limited company is a different legal entity from its shareholders and is owned by the shareholders and run by directors.

Your choice is critical and will affect your tax bills, the extent of liability you are exposed to should things fall apart, and even how professional or credible your business appears to others. In that case, how are you to decide the best thing for you and your startup?

What Is a Partnership?

A partnership is a business in which two or more persons combine their assets and skills. There are two main types:

• General partnerships – where all partners are equally responsible for the business and their debts.
• Limited partnerships – partners who are not involved in the day-to-day decision making and just invest financially.

In a partnership, everything is at stake, from money (profits and losses) to decisions. Each partner is also jointly and severally liable for debts of the business, which means if the company runs into trouble, their assets (including savings or even a family home) are at risk.

A partnership agreement (though not a legal requirement) is advisable. This can lay out things like how profits will be divided, what happens if one partner wants to leave and how decisions are made. It can save on a whole lot of problems down the line.

For tax purposes, partners are self-employed and every partner is taxed on his or her share of the profits. The partnership itself is not a taxpaying entity; profits “flow through” to the partners, who report them on individual income taxes.

What Is a Limited Company?

A private limited company (Ltd) is a type of business that is legally distinct from its owners. This means it can own property and incur liabilities, and enter into contracts in its own name.

Shareholders own, and directors govern. For smaller businesses, the two groups are often one and the same. One of the big pluses here is limited liability. If something is to go wrong, you are generally only liable for what money and resources you’ve put into the business rather than your personal assets.

However, there’s more admin involved. A limited company needs to register with the Companies House, prepare annual accounts and must submit a Confirmation Statement every year. They must also pay a Corporation Tax on profits, and directors may need to pay additional personal tax on any salary or dividends drawn.

The more positive side of this structure is that it often appears more professional to your clients and investors, which can later on facilitate the fundraising process. But that is not always the best choice for everyone, particularly when you’re new to the game, or if you want to keep it simple.

Key Differences Between a Partnership and a Limited Company

Here’s a side-by-side look at how the two structures compare:

So, what does this look like in practice? If it is a small business with only one or two people involved and of relatively low-risk level, it may choose not to incorporate and opt for a partnership instead. Yet if you expect to scale, need funding or want to mitigate personal financial risk, a limited company may suit you better.

Pros and Cons of Each Structure

Partnerships are very flexible, easy to establish and perfect if you have the right partner who has strength in areas where you may lack. There is less paperwork and no Corporation Tax! The counterpoint is the unlimited liability; if something is to go wrong, you may be putting your own money on the line. Moreover, incongruities can eventually emerge, and in the absence of a contractual agreement, things could break down.

On the other end of the scale are limited companies, which offer more financial protection and usually a bit more credibility if you need financing or want to win bigger clients. Yes, but then there are more admin and a slightly more complicated tax aspect.

Example: Two plumbers opening a local service together is very plausible as a partnership. However, if you are entering the tech startup class playing for growth and funding, then a limited company structure will afford the most flexibility and safety.

Factors to Consider When Choosing

So which is the best for you? A few thoughts to keep in mind:

• Personal liability: A limited company will limit this risk.
• Funding: Investors and lenders prefer limited companies.
• Tax advantages: You could save on some taxes if the structure allows a limited liability company to be more beneficial, particularly when revenues are substantial.
• Admin capability: Do you want to take on additional paperwork or hire a stronger administration person (or feature)?
• Vision for the future: How do you see the business in 2, 5 or 10 years? Your ambitions will mould the ideal form.

There’s no general answer. What works now might not suit you forever, but getting it right at the start can save a lot of hassle later.

Conclusion

Limited company vs partnership is not as simple as just checking one box or another, as it will affect your business, your tax obligations, and the risks associated with limited or unlimited shareholders.

System partnerships are easy and involve joint accountability, but carry individual risk. Limited companies are a good way to protect yourself legally and allow you to scale up, but it comes with administration and compliance.

That doesn’t mean one structure is better, it just means one fits your business best. If you want our help guiding you through the decision, handling the setup and continuing to keep things on track, we are here for that too at Reed & Co. Let’s make business simple.