You will need to decide whether to operate as a sole trader, form a limited liability company (or buy an existing company), or enter into a simple or limited liability partnership with one or more other people. These structures differ in complexity, associated costs and exposure to legal and tax risks. The best option will depend on the nature and scale of your intended activities and how you want to work with any partners in the business.
We look at the general pros and cons of each structure below, but you should consider engaging a legal or tax adviser if you have specific issues you need to think about.
No set-up formalities, you are good to go. No reporting obligations other than VAT and income tax. Full control over your business, trading under your own name or a different trading name if you like. (You can register your trading name at Companies House even though you're not registering a company, which can help deter others from using it.)
What's not to like? Well, your business income is your personal income: the more you earn, the higher your personal income tax rate may become. Further, if things don't go well, any business debts, or business liabilities to others (for example damage caused by defective products or services you provide, or wages or pension obligations to any employees) are your personal debts or liabilities, and this liability is not limited in any way. Your house and other assets are on the line.
No set-up formalities
Simple tax arrangements
Unlimited personal liability
May be harder to split up the business if you only want to sell part of it.
LIMITED LIability company
The set-up is more complicated. You need to register a company at Companies House, appoint at least one director, and create one or more shares to be held by one or more shareholders. You will need to create and file company 'Mem & Arts:' a Memorandum of Association signed by all shareholders at the time of incorporation (agreeing to form the company and take shares) and Articles of Association (rules for running the company, % votes needed for different company decisions, signed by shareholders and directors).
Each year, you also need to file with Companies House an annual accounts statement and a confirmation statement (confirming company name and registered office, naming all directors and shareholders and identifying all 'persons of significant control' with ability to substantially influence company decisions). Any changes to the directors or shareholders also need to reported to Companies House straight away. It is worth noting that as a director you have a duty to act in the best interests of the company - not your own best interests. This potentially becomes more of an issue as your company grows.
The company needs to report and pay VAT, and then there are two points of tax on business profits. As a separate legal entity, the company needs to report and pay corporation tax each year. When you take out profits via a salary or dividends on your shares, you will also need to pay personal tax on this income.
However, any business debts or liabilities to other parties are the debts and liabilities of the company, a separate legal entity, not your personal debts or liabilities. Furthermore, the company's liability is limited to the value of its assets and the shares. Your home is safe. (Unless you have acted fraudulently as a director, say, in which case the courts may decide you should be personally liable - but that's not going to happen, right?)
Limited liability of company, not you personally
Low tax rates on share dividends can potentially reduce tax payable compared to sole trader
May be easier to sell just part of your business (some of your shares)
More credibility with investors/partners/customers
More set-up and reporting formalities and paperwork to manage (possibly higher legal/tax/accounting costs)
Less control over the business as it grows
A partnership can be 'simple' - an agreement between individuals to run a business together, sharing the profits equally or as allocated in the partnership agreement, and each partner then paying personal income tax in the same way as a sole trader.
A simple partnership has unlimited liability, and all the partners are together responsible for all the debts or other business liabilities incurred by the partnership - even if a particular partner was not involved when things went wrong. If no other partner can pay, you could be liable for the whole lot.
Another form is the limited liability partnership: incorporation documents need to be filed at Companies House, and there are more formalities and recording obligations. However, the liability of the partnership for any business debts etc. is limited to the assets of the partnership. Each partner's home and personal assets are ring-fenced. This structure is mainly used by professional services firms if lawyers, accountants and so on.
If you are planning to set up a charity or other non-profit organisation, you have a couple of other options.
You could set up a company (registered at Companies House) that is 'limited by guarantee' - no shares or shareholders, just company 'members' acting as guarantors for the company. Alternatively, you could set up a 'charitable incorporated organisation' (with the Charity Commission, not Companies House). Charitable status would exempt you from corporation tax.
So how do i choose?
If you have specific issues you would like to understand in more detail before deciding, you should seek appropriate legal or tax advice. However, in general: if you are likely to generate enough business income to push you to the highest personal income tax bracket, or you are likely to face the risk of significant liabilities to others (for example because you are taking on employees or maybe selling higher risk products or services) - it is worth considering setting up a limited liability company, or perhaps a limited liability partnership if you will be providing professional services.