Types of business

Author
Dominic Claeys-Jackson, Editor
Posted
January, 2017

If you want to become self-employed, you'll need to choose from one of several types of business structure, but be warned - your selection will have tax implications and affect your legal responsibilities

There are three main types of business that those seeking self-employment can look to establish: sole trader, partnership and limited company. Each differs in terms of the paperwork you must complete, the tax you must pay, the way in which profit is distributed, and your personal responsibilities if the business makes a loss.

Sole trader

This type of business is owned and managed by one individual. There's no legal distinction between the owner and the company, meaning that all debts and after-tax profits are personally yours - this is called 'unlimited liability'. Specialist service providers such as plumbers, hairdressers and electricians are often sole traders.

Sole trader businesses are easy to establish and discontinue, are subject to relatively few regulations, and typically have relatively low running costs. The owner is responsible for keeping day-to-day financial records, but hands responsibility for the end-of-year accounts to a professional accountant.

On the downside, sole trader businesses can be difficult to keep afloat, and owners will often work long hours and take few holidays. There's nobody to share responsibility with either, meaning any business weaknesses you have may be exposed.

Partnership

Similar to sole traders in the sense that they are subject to unlimited liability, partnerships differ in that they involve two or more people pooling their expertise to own and manage the business. Professional service providers such as dentists, doctors and accountants often fall into this category.

A deed of partnership usually states how much capital each individual has contributed, how profits and losses are to be shared, and which partner is tasked with bookkeeping. Each partner pays tax and National Insurance on their individual profit.

Partnerships usually offer the advantages of shared responsibility, reduced time pressure for each individual, and an increased level of financial clout and specialisation.

However, making decisions can be difficult. What's more, one partner may feel that another isn't putting in sufficient effort, or is earning a disproportionate profit.

Limited company

There are two types of limited companies: private limited companies and public limited companies. The former are often small businesses that don't trade on the stock exchange, while the latter are usually well-known businesses that do.

Unlike sole traders and partnerships, these businesses are registered at Companies House and have their own legal rights and obligations. Ownership is divided into equal parts called shares. Anybody who owns one or more shares is a shareholder.

Limited companies offer limited liability - which means that the business, rather than its owners or managers, enters into contracts, employs people, takes debts and profits, and is liable to prosecution if criminal offences are committed. A limited company's owner isn't necessarily involved in the day-to-day running of the business, unless they are elected to the Board of Directors.

Other business structures

There are several other types of business, some of which must nevertheless be registered as one of the three business structures outlined above.

  • Franchise - This is an already established company, such as McDonald's, KFC and Hertz, that is owned by a franchisor but managed by a franchisee. The franchisor sells the right to use their business model to the franchisee, who pays an ongoing fee. Workload and start-up costs are usually lower, business finance is more easily acquired, and relationships with suppliers, distributors and marketers already exist. However, large ongoing fees restrict franchisees' long-term profits, cheaper operating methods cannot be used unless sanctioned by the franchisor, and any negative action by a fellow franchisee may damage business.
  • Freelancer/consultant - These individuals have the skills, knowledge and experience in a particular field to charge organisations for their services. The most common jobs for freelancing or consultancy include actor, acupuncturist, barrister, broadcast journalist, fine artist, musician, osteopath, photographer, production designer, television camera operator, textile designer and web designer.
  • Social enterprise - This type of business is operated to benefit society or the environment, and must transparently reinvest profits to achieve its objectives. There are around 70,000 social enterprises in the UK, employing almost one million people and contributing £18.5billion towards the economy. There are several different types of social enterprise, most notably cooperatives, credit unions, development trusts, employee-owned businesses and housing associations. Two well-known social enterprises are The Big Issue Foundation and the Eden Project.
  • Charity - While the trading arm of a charity can be classified as a social enterprise, the charity itself cannot. This is because it differs in the sense that income is attained through grants and donations, rather than trade. Charities pay reduced business rates and receive tax breaks, and are normally run by trustees who don't themselves benefit from the charity.

Self-employment is most common in the accountancy, banking and finance, creative arts and design, healthcare, information technology, law, leisure, sport and tourism, and media and internet sectors.

Find out more