The Importance of Choosing the Right Business Structure from Day One
Posted by Seán Kennedy on 29th March 2018
People make many important choices when starting a business, such as where to locate and how much to invest. However, arguably the most important decision of all, and the one with the most sweeping consequences, is their choice of business structure.
The structure of a business affects such far-reaching issues as who will make critical decisions in the future, how much tax the business will pay, how profits and losses will be distributed among key stakeholders, and the nature of the liabilities faced by the business owners.
Types of Business Structure in Ireland
Let’s take a look at the types of business structure you can choose from before exploring their implications. The goal is to invest your hard-earned capital in the business structure that most appropriately balances risk and reward.
A sole trader is a single-owner structure, where one person owns and runs their own business. As such, sole traders are entitled to keep any profits they make after tax. However, he or she is also liable for any debts incurred by the business.
Starting your business as a sole trader is straightforward and requires less paperwork than if you were to start a limited company. Furthermore, you as the sole owner, get complete control over all business decisions. Freedom and flexibility are the main advantages of this structure.
Becoming a sole trader is not without its drawbacks, though. Sole traders take on the burden of unlimited liability—they are personally responsible for settling all business debts that arise. Due to unlimited liability, a business owner’s home and other possessions may be used to pay outstanding debts if the business does not have enough funds to meet them.
This option also has tax disadvantages. Not only must a sole trader submit an annual tax return to Revenue, but they are liable for tax at the personal rate of 20-40% in addition to PRSI and Universal Social Charge (USC) payments of 4% and 11% respectively.
Sole traders also bear the burden of keeping their own books and records in case the Revenue requests clarification on any aspect of their tax affairs. Finally, a person registered as self-employed can have a hard time getting social welfare payments if the business goes under and they need some support.
A partnership is similar to the sole trader structure, but it involves more than one owner. Each owner can share in the profits of the business after tax is paid. As with the sole trader structure, a partnership business is easy to set up.
Each owner can be held personally liable for the debts of the business in a partnership. If, for example, one partner leaves the business, the remaining partner or partners become responsible for business debts.
On the flip side, the unlimited liability of sole traders or partnerships can be seen as an advantage, in that financial institutions might lend to such businesses more readily, knowing that the owners are personally responsible for the debt.
Where a limited company is formed, the company is registered as a separate legal entity. Under this arrangement, ownership of the company depends on an individual’s shareholding.
The liability of each owner is limited to the value of the shares they hold. If, for example, one person starts a limited company with capital of €40,000 and the business gets into debt it cannot pay, the owner is not at risk of losing his or her house or other possessions. They lose only the €40,000 worth of shares they invested and no more. This makes setting up a limited company much less risky than starting a business as a sole trader or partnership.
Significant tax benefits are available to limited companies. In Ireland, companies are taxed at the generous corporate tax rate of 12.5% of profits, which is much lower than the personal tax rates paid by sole traders or partnerships.
Companies can also benefit from various grants, such as the New Frontiers programme for innovative, early-stage start-ups.
On the negative side, it is more complex to begin trading as a limited company. Furthermore, limited companies must comply with numerous statutory requirements to satisfy Revenue and the Companies Registration Office.
If a limited company owner wants a share of the company’s profits, these have to be extracted in a variety of ways. The method chosen to take a profit can have a huge bearing on its size. In such a scenario, it’s important to get sound financial advice as the wrong decision can be an expensive one.
This business structure is a rarely-used combination of both partnership and a limited company. Such businesses consist of a general partner, who is personally responsible for company liabilities, and one or more limited partners, who are only at risk of losing the money they invest in the company. Few limited partnerships are registered here, but it is another option for would-be entrepreneurs.
Choosing the right business structure from day one is critical for anyone seeking to start their own business. Aspiring entrepreneurs should do their homework at the outset to avoid having to deal with unexpected headaches later.
The choice of business structure has implications ranging from liability, to legislative requirements, taxation, the power to make decisions, and even future entitlement to social welfare payments. Entrepreneurs must balance the pros and cons of each structure and measure them against their own appetite for risk.
If you are considering making the move from sole trader to limited company and need to invest in some expert advice, Linked Finance could provide the capital you require.