One of the most important decisions you will make when launching a new business concerns the legal structure you adopt. The legal structure of your organisation will determine everything from the type of tax you pay to your personal liability. The four most common legal structures applied in the UK are:
- Sole trader
- Traditional partnership
- Limited Liability Partnership (LLP)
- Limited liability company (Ltd)
In this article we will carefully examine the latter two options, explaining their advantages, disadvantages, and LLP vs Ltd. Before we do, however, it is useful to briefly explain the key features of an LLP and a limited company.
The Limited Liability Partnership Act 2000 (LLPA 2000) provided for the creation of LLPs on or after 6 April 2001.
An LLP is a halfway house between a traditional partnership and a limited company. Professionals such as solicitors, dentists, architects, and engineers commonly structure their business as an LLP. This is because the structure works well for business owners who have no ambitions to rapidly grow their offering or staff numbers. Liability is limited meaning that if the LLP falls into insolvency or is in breach of contract the individual partners are not normally personally liable.
Limited liability company
A limited liability company (a company) is a separate legal entity from its owners (known as shareholders or members). This means a company can enter into legal contracts and take on liabilities in its own right. The company’s shareholders’ liability concerning the company falling into insolvency or breaching its contractual obligations is limited.
What are the advantages of an LLP?
The key features and advantages of an LLP are as follows:
- An LLP is a separate legal entity, therefore limiting the liability of the members.
- It has the legal capacity to do anything a natural person can do, including entering into a contract and applying under a tender process.
- The partnership agreement is confidential and does not need to be filed with Companies House.
- No share capital is required and unless something to the contrary is agreed by the members there is no requirement for any of the partners to contribute capital.
When it comes to running a business as a partnership the main advantage of an LLP over a traditional partnership concerns the application of the Partnership Act 1890. This Act covers partnerships that are formed by a verbal agreement or even by mere conduct, the latter known as a ‘Partnership at Will’. The Partnership Act 1890 is deemed by many legal professionals to be largely unfit for modern business because:
- Under the Act, all profits are split equally regardless of the time and effort each of the partners contribute to the business.
- If a partner chooses to retire the partnership must dissolve, the assets distributed, and a new partnership formed.
- A partner cannot be expelled from the partnership. Again, the partnership must be dissolved, and a new partnership created.
An LLP can exist without a Members’ Agreement, however, it is always advisable to have one covering:
- The rights and obligations of each member.
- Means of regulating each member’s investment in the LLP.
- Details on who owns the partnership’s assets.
- How profits or losses will be shared.
- The governing of the LLP and how major decisions will be made.
What are the advantages of a limited liability company?
Similar to an LLP a company limits the liability of its shareholders/members and is a separate legal entity. Other advantages of a company include:
- Shares can be transferred in exchange for investment or if a shareholder wishes to exit the company.
- As the company is a separate legal entity there are no limits to its growth potential, unlike a partnership where growth depends on the personal capabilities of the partners.
- The shares in a company can allow for equal ownership or different rights and/or restrictions can be attached to different classes of shares meaning that new shareholders’ ability to control the company is restricted.
LLP v Ltd – what are the similarities?
Given that both LLPs and companies confine the liability of their members and are separate legal entities there are naturally several similarities between the two, including:
- Incorporation and set-up – both LLPs and companies are incorporated at Companies House. Although the former will have members and the latter directors and shareholders, these labels essentially refer to the same thing – the people who own the business. Both legal structures will have governing documents. In the case of a company, this is its Articles of Association and Shareholders’ Agreement – an LLP will have a Members’ Agreement.
- Filing requirements – both LLPs and companies must file annual accounts and confirmation statements with Companies House. In addition, a register of people with significant control must also be created and maintained by both types of legal structures. It is also the responsibility of company directors, company secretaries and LLP designated members to inform Companies House, HMRC, and all other relevant parties if certain changes occur. You will also need to update most of the reported changes in your statutory records.
If any of the below information changes it must be reported to Companies House:
- Company or LLP name
- Registered office address
- Single Alternative Inspection Location (SAIL address)
- Moving statutory records
- The records retained at a SAIL address
- Officers’ and members’ details
- Accounting reference date (ARD)
- Share structure
- Articles of association
To register changes at Companies House you will need the email address and password you used to sign up for the organisation’s online services and the authentication code sent to your registered office address.
- Floating charges – Both LLPs and companies can grant fixed and floating securities over their assets as security.
Although there are several similarities between LLPs and companies, there are also many differences that you need to be aware of when considering which is the best legal structure for your business.
LLP v Ltd – what are the differences?
The differences between an LLP structure and a limited liability company include:
- Flexibility – when it comes to flexibility regarding structure, LLPs have an advantage over companies. This is because the affairs of a company are regulated by the Companies Act 2006 which is a great deal more restrictive than the legislation governing LLPs. For example, the Companies Act sets out seven duties a company director must comply with, namely:
- To act within powers.
- To promote the success of the company.
- To exercise independent judgment.
- To exercise reasonable care, skill, and diligence.
- To avoid conflicts of interest.
- Not to accept benefits from third parties.
- To declare any interest in a proposed transaction or arrangement with the company.
Failure to comply with directors’ duties can result in a claim being brought against the director or even criminal prosecution. In contrast, an LLP member who has direct control over the affairs and/or property of the business is likely to owe a fiduciary duty to the LLP similar to the directors’ duties referenced above, however, a passive member who does not take part in the day to day running of the business is likely to owe little or nothing in the way of fiduciary duty to the LLP.
- Privacy – although both LLPs and companies must file accounts and notify Companies House of certain changes (see above) a key difference between the two is that a company must also file, and therefore make publicly available, its Articles of Association. An LLP Members’ Agreement, on the other hand, is a confidential document.
- Tax – LLPs are taxed in the same way as a partnership, i.e. the members are taxable as individuals both on profits earned by the LLP and capital gains resulting from any asset sales. LLP members are treated as self-employed and pay income tax on their share of the LLP’s profits. In contrast, a company is treated as a separate legal entity for tax purposes and is liable for corporation tax on the company’s profits. Shareholders will pay dividend tax and capital gains tax where applicable.
- Attracting investment – the legal structure of a company makes it easy to onboard investors as they can simply buy shares in the company without having to become a director. In the case of an LLP, however, an investor would need to become a member. Furthermore, exiting an LLP is not as easy as transferring shares in a company.
LLPs and limited liability companies are both common legal structures for UK businesses. It is important to consider the advantages and disadvantages of each structure when deciding which one is appropriate for your venture. Our team at Uniwide are always available to answer any questions you may have.
Uniwide Formations specialises in the registration of limited companies and LLPs. As professional business service providers, we offer a wide range of related services and can advise you on all aspects of company and LLP formations.