Business Structures: The risks of getting it wrong- Part two

In part one of this blog series we explored a range of business structures that may be suitable for your client, including the upsides and downsides of sole traderships, partnerships and LLPs.

However, with around a quarter of all UK businesses choosing to set up as a limited company, it’s definitely an option not to be missed when discussing this with your client. 

Limited companies can either be publicly owned, as many of the large companies are, including 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, known as parent companies. Individuals are often also directors of the company. It’s important to note that the administrative burden for limited companies is greater than for simpler structures, such as sole traders, with regular filings required at Companies House.

A limited company will have its own constitution, comprising memorandum and articles of association (setting out the company’s objects and powers, as well as the rules governing how the company will regulate meetings and decision making, etc). 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. Clients should always be encouraged to seek proper advice before potentially exposing themselves to personal liability in these types of situations.

It’s important to explain to your client that nothing is forever, and business structures do change. A sole trader can decide to go into partnership with others and then convert to an LLP or another entity, like a limited company, or the reverse. Company family trees can be complex, with companies being owned by individuals, partnerships, LLPs or other companies both in the UK and overseas.

Above all, if you’re advising someone who’s looking to set up as a business, the most important thing is that they take proper advice, including tax advice to choose the structure that is most effective for them. Not only can it be costly to set off on the wrong foot, but there can also be a significant litigation risk that could otherwise have been avoided. 

Stuart Evans, commercial litigation partner and specialist in business disputes at law firm BLM

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