Step 1 Business Structure
The first step for any business owner is to understand what structure their new business should have in order for it to be run most effectively. Getting this right in the beginning is important because you don’t want to find that seven months down the line, when the business is flying, that you have to change structure. Generally, we do this by fast-forwarding 12-18 months; we look at the potential of the business, try to understand what it might look like in the future and create the right structure to support that business. For the majority of UK businesses there are four options; two unincorporated and two that are incorporated with Companies House.
An unincorporated, sole trade business is the simplest setup. You need to prepare a simple profit and loss account and file an annual tax return with HMRC to report your profit, but that is it. But remember, as a sole trader, you are taxed on this profit, whether you take the funds out of the bank or not.
A partnership is exactly the same as a sole-trader, except there are two or more people of equal standing in the business. You have to file a partnership tax return and then personal tax returns each year but your business remains unincorporated.
Limited Liability Partnerships (LLP)
LLPs offer you the liability protection that a company does but the tax position of a partnership. The only real benefit of an LLP type structure is that if you have a business that changes owners fairly regularly, like a professional services partnership, which has partners retiring, new partners coming in, you use the LLP, which is easier than a private limited company to do that.
Private Limited Companies
Within our client base, Cypher supports around 96% private Limited Companies as this is the route that is most suitable for our clients. Typically, assuming you will make a profit of more than £45-50,000 a year, then this is the most tax effective way to set up a new company.
The largest benefit for doing this is liability. As a separate legal entity, limited companies not only protect their owners from certain liabilities, but stand to be more tax efficient than sole traders. Being incorporated protects the business owner from being sued and losing their personal wealth, possessions or even their house. Assuming you don’t do anything fraudulent, as a business owner you are only liable for the amount of share capital you put in at the start or any outstanding funds, like bank loans that you may have personally guaranteed.
The second benefit is the tax efficiencies. As a sole trader, you are taxed on all of your profits, whether you take funds from the business or not. As a limited company, companies pay Corporation Tax on their profits of a flat rate of 19%. Directors can then minimise their personal tax and National Insurance Contributions (NIC) by paying themselves a mixture of a salary and dividends. Broadly speaking, limited companies are often more tax efficient than sole traders. In addition, there’s a wider range of allowances and tax-deductible costs that a limited company can claim against its profits. Sole traders do not have the same tax benefits. They pay 20-45% Income Tax on all taxable earnings, as well as Class 2 and Class 4 National Insurance.
The third benefit of incorporating your business is that you will seem much bigger than perhaps you are. This can be important when a potential client or customer is researching their options.
Step 2 What’s in a Name
A lot of people get bogged down with this when, in reality, you can trade as anything you like. Honestly, if you can’t think of a name, use your favourite colour, followed by your favourite shape or animal. There are, of course, some other considerations; you may want to see what web addresses are available or similar URLS used by a direct competitor but this doesn’t stop you registering your company in the first place. You may also want to buy your favourite web addresses in advance, no harm in planning ahead.
Step 3 Shareholders v Directors
If you have decided on a limited company structure and have chosen a name, you then need to identify shareholders, who own the company and directors, who will run the company. Often they are one and the same, but there is no requirement for them to be so. For example, a business may be owned by husband and wife but in reality it is the wife’s business and she is the sole director. The reason the shareholding is important is that any dividends paid out need to be in proportion to share ownership. If it is a 50/50 split, then one director can’t be paid 100% of the dividends.
Step 4 A registered office
Next, you need to set up a registered office, which can be your house, or preferably your accountant’s. If someone wants to offer you a sizable contract, it helps that your business has a recognisable address, and not just your shed!
Step 5 Bank Account
It is very important that you set up a business bank account that you treat as 100% separate from your own. It is NOT your money until you pay it out to yourself! Even as a Sole Trader, you need a separate account. As a limited company, as a separate legal entity, it is important to make a distinction between what’s yours and what is the companies.
Step 6 Payroll
If a business owner intends to pay themselves or any other employees more than £113 a week, they should first register for a payroll scheme with HMRC. Businesses can choose which payroll system to use and it will help record employees’ details, work out employees’ pay and deductions, report payroll information to HMRC and calculate statutory pay, for example, maternity or sick pay.
Step 7 VAT
A lot of people don’t want to register for VAT because they see it as an extra burden. You have to do a return every quarter. And, if you deal direct with consumers, then potentially you become 20% more expensive than your competition. But if you are Business to Business (B2B) then you are VAT neutral. Your customers are able to claim the VAT back and you can recover the VAT that you are spending. So really as a limited company, services business customers, there is no reason not to do it. The thing about registering for VAT is that it gets you into good habits by making you do your accounts each quarter in order to file the return. It often makes your business look a lot bigger than it actually is, offering it a level of kudos. Of course, if you are fundamentally scared of your bookkeeping, you should outsource it immediately and let someone take care of it for you.
But in reality, using a cloud-based solution like Xero, the quarterly VAT returns can almost be a simple as pushing a button.