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Alternative trading vehicles

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Choosing a trading vehicle for your business can be risky and uncertain. Our host sits down with Adam Percival, Senior Associate in our Corporate team, to discuss alternative trading vehicles for those looking to set up a business.

In this episode:

  • Defining a trading vehicle
  • The 4 most common trading vehicles
  • Advantages and disadvantages of these vehicles
  • The differences between a private and public company
  • Different forms of partnership

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This episode is part of our straight talking business success podcast series. Learn more about the series and what we cover.

Read the transcript:

Host: Welcome to Straight Talking Business Success, your guide to growing and developing your business.

Host: Today I'm joined by Adam Percival, senior associate on our corporate team, and today he's going to be talking about alternative trading vehicles. This is a really key lesson for anyone who's thinking about setting up a business. Before we get into the different types of trading vehicles, Adam, it'd be really useful if you could just give a brief overview of what we mean by trading vehicles.

Adam Percival: Trading vehicle can be either an individual or a group of individuals who come together to look to operate a business for the means of generating, usually, a profit. In the case of companies that can be an incorporated entity. So you can have an individual, you could have, say, a group of individuals or a company which is registered and incorporated and is a little bit more formal. But the common aim is to operate a business for the benefit of the owners of those business to generate profit in the long term.

Host: Excellent. Okay, so what do those different vehicles look like? What alternatives could someone who's looking to set up a business choose from?

Adam Percival: So the four main ones that we tend to see in use, two are more often asked about when people are looking at setting up a company or a business. So, the first one is a sole trader and that is an individual trading on their own account, being their own manager, essentially their own boss running the business on their own with a view to making profit and they're trading off their own account. So, they own their own assets and they just trade off their own name essentially.

Host: Okay.

Adam Percival: And then with the next one, which is quite a common vehicle, is a company which is limited, so that's a private limited company. So, the difference between that and a sole trader is that the limited company itself is its own separate legal entity. So, it can own its own assets, it can sue, it can be sued, but it's separate and distinct from the individual. This means there is a difference in the roles that individuals play in the company, so you can have the shareholders and you'll also have directors. And that's primarily the difference. The other two, which we'll come onto later, are partnerships and limited liability partnerships.

Host: Okay. So is it the case that you have to formally set up a company in order to trade?

Adam Percival: No. A sole trader can trade off their own account, and that may be perfect for that individual depending on their needs, in the long term, they may look to have a business which will not necessarily grow to a large scale. So, it's quite appropriate for them to trade on their own account and they'll have the benefit of flexibility that they can do that as an individual. There's no filing requirements and it can all be kept quite private. So, there's no heavy load of documentation that would involve lawyers and start-up costs. So, it's attractive for the classic one man band.

Host: Okay.

Adam Percival: But, with that, means that essentially you are trading off your own accounts. That is you trading privately, which can have disadvantages.

Host: Okay. So, building on that, what are the advantages of trading through a company?

Adam Percival: The main advantage is having the ability to be shielded by the corporate entity and have limited liability. So, if a company is sued for debts, etc, it's the company which would have to pay those debts. It's not the individual. With the sole trader, it is the individual which has to be responsible for paying those debts. And that can lead to potentially a sole trader having their home, their car, their personal assets being at risk, where a shareholder in a limited company pays its share-holding and that's its liabilities and capped at that amount that it puts into that company.

Host: And are there any other advantages?

Adam Percival: Yeah, so the limited company can be used to have more than one individual in it, so you can have multiple shareholders. There different rights and participation in that company can be governed by the documentation you put in place. So you can have different shareholdings having different rights. If you're looking to raise money, particularly at early stages when you're looking to decide whether to be a sole trader or limited company, you may well require funding.

Adam Percival: So it's quite often the case that a funder will look to or could look to take an equity stake in the business. Any third parties that you talk to, so for example, banks, accountants, suppliers, they take comfort from the fact that there is a limited company in existence. They can go to Companies House, which is the registry where you file detailed late into the company and they can basically verify the fact that the company is in existence and who the owners and the directors are. And as I said earlier, they are so common that everybody has a certain comfort level in dealing with a limited company. So those are the main advantages.

Host: Okay. So, on the flip side, what are the disadvantages associated with a limited company?

Adam Percival: The two main ones are that of transparency, so you have to file a certain amount of information at Companies House. So that means you have details of your company, the directors, the shareholders, their shareholdings, all stored at Companies House, which on one side gives people who you're trading with great comfort because they can tell it's a legitimate business entity. On the other hand, people aren't necessarily quite so comfortable filing things like shareholder details, accounts, etc. You do have to submit a lot of personal information to Companies House when you incorporate, but that's not all publicly available, but there is a raft of information that is publicly available and can be accessed by anybody via the internet.

Adam Percival: Moving onto responsibilities, the directors of the limited company have a number of statutory duties including to act in the best interest of the company and promote the success of the company. They also have duties to the shareholders, creditors and employees. So if there is a claim against the company or by the company, sorry, for a breach of those duties, it could be that the director is actually claimed against by the company itself which with an owner managed business which has started applying is half may not be an issue because the director and the shareholder is one in the same, albeit they have different roles in the company but that cared about the same person but when you get to a larger size you might have an issue whereby the shareholders are not the same as the directors and the directors could have an issue with the claims brought by the company.

Adam Percival: Another issue with that aspect is that you need to make sure the company is trading solvently, so if the company becomes insolvent or it looks like it's going to become insolvent, the directors need to make sure that they take advice early to rectify that. Otherwise liquidators could come in and then they could be bringing a claim on behalf of the company and the creditors against the directors so directs could be personally liable for failing to deal with their duties in the correct manner.

Adam Percival: We've talked about already the limited liability status, which at the outset is correct, but considering the company can be incorporated with just a one pound share, anybody who is looking to trade with a business or provide the business with credit may well seek greater comfort that their credit is secured in some way, shape or form. This quite often can take form of personal guarantee by one of the directors which then circumvents the limited liability status and actually the individual who gives the personal guarantees assets that are at stake. This happens or can be requested when a company has got very small or very short trading history and is a genuine new co start-up. The more trading history has the greater comfort third party creditors have and they can check and they can look at companies, house check the accounts, run credit scores, etc, so that is less relevant the older the company gets to a certain extent, but there are always scenarios where depending on the amount of credit you're looking to acquire, personal guarantee may be required from the directors or main stake holders.

Adam Percival: Moving on to the element of taking cash out of business or profits out of a business with a sole trader, you will just be taxed in the usual way for income with a company there is double taxation's, the company's tax on the profits initially it makes.

Host: Okay.

Adam Percival: And then when shareholders extract casual, in the case of an owner managed business, a director and a shareholder looks to extract the cash. They'll pay tax on their remuneration and any dividends or any proceeds from a sale.

Host: Okay, so there's a kind of a double layer of tax.

Adam Percival: Yes, absolutely.

Host: Quite a few points to consider that useful if you could give an overview of the difference between a private company and a public one.

Adam Percival: Public company, it has the ability to trade on regulated market. So, the main stock exchange or aim for example, but only public companies can do that and be listed. You can have a public company which isn't listed so long as it complies with the parameters on incorporation's... on the corporation, sorry. So they have to have two directors, qualified company secretary. There's a minimum share capital requirements as well. Although they aren't traded on a recognised stock exchange, for example, they are still so get to things like the takeover code and greater regulation. So, a company may not be traded on the stock exchange, but if it looks to sell, it still needs to comply with the takeover code. So, people need to be aware of that early in the transaction process, so they can get the relevant exemptions from the takeover panel. Public companies are subject to the greater restriction and regulation because the whole concept of a public company is to raise funds and you can have a whole variety of institutional investors, for example, pension funds, things like that.

Adam Percival: Or you can have retail individuals, you and I could invest in any sort of company which is listed on the stock exchange. So there's a high level of regulation there to protect all the investors to make sure that everybody's protected. Another difference between the two is that you're likely to have a far wider and larger shareholder base with a public company. The board of directors will be distinct from that shareholder base as opposed to an owner managed business, for example, primarily when it's listed, the shareholder base will be significantly larger than that you'd expect for an owner managed business and the board will be distinct from that shareholder base, although they may well hold shares and quite often expect to hold shares in the company as well.

Host: Okay. So earlier on you mentioned partnership briefly, can you explain how partnerships fit into this decision?

Adam Percival: Right. Okay. So partnerships are essentially a collective of sole traders. So again, there's no separate entity. So, the partners involved in the partnership will all be personally liable. So again, it's their personal assets which potentially liable that makes holding assets entering into contracts more tricky than with an entity. It's got its own legal entity because the various partners hold the assets and profits on trustful for one another. There's the unlimited liability element, which we just mentioned and the fact that each partner combined the co-partners whenever it enters into a contract with a third party. One of the benefits though of a partnership is that it's not incorporating, therefore it doesn't have the same level of filing requirements...

Host: Okay.

Adam Percival: That a limited company would need. So it's much more private. So details can be kept out of public eye. Many professionals initially set out as partnerships initially for that reason. And then different kinds of partnerships, limited liability partnership, which is a hybrid between a limited company and a partnership. So there's a separate legal entity there which can own and hold the assets and then the partners have varying roles in that they can just be a partner and involved in the investment element of the LLP or they can be also the managers as well.

Host: So are there any different forms of partnership?

Adam Percival: You could have a limited liability partnership, which is hybrid between a partnership and the limited company. So the partnership as a separate entity which is incorporated and details can be found at Companies House but it's still a partnership at heart. You lose some of the privacy around it because of the transparency requirements but it does give the ability for a partnership to act in an arrangement which is more akin to a partnership but still has that limited liability and separate entity status.

Host: Okay. So there are some benefits in there for the members of that partnership over over a kind of general partnership. It's really useful background on one of the different vehicles that are available. So on to the key question really for an individual setting up their business, how do they go about choosing the right vehicle?

Adam Percival: It depends on the circumstances of that individual. In the short and medium term. The issues will usually be driven by where they want to get to, the people that they want to involve in this enterprise, whether it's just going to be them as an individual or a group of people, whether they're going to look to raise finance for example, and generally they need to have a a bit of a view to the future to see where they, where they want to get to the plan and what they want to achieve. There will always be some tax planning considerations which you need to have and they can discuss that with their accountant and again sometimes that may well have some bearing on the vehicle which is chosen. The fact that private limited companies are so flexible means you quite often see those in used as a trading vehicle because you can sort of take the majority of those boxes, but it does depend on a variety of factors. And how much transparency and protection the individual wants to be prepared to have in that arrangement.

Host: Okay. So when such been settled on a decision has been made, it's obviously our hope that that business is going to grow and evolve over time. Is it possible further down the line, to change the entity effectively choosing another vehicle at a later date?

Adam Percival: So you could have a situation where am I, I'm a sole trader or a partnership? Which is to incorporate, they then set up their new co and transfer the business and the operation and the assets from the individuals across to that new co so that could be achieved. You can also take a new co and have public status and become listed further down the line.

Host: Okay.

Adam Percival: You can also, as you might have seen with some football clubs over sort of the last decade or so being de-listed and taken from public to private. So again that's possible. There is a legal mechanism to do that. It requires a certain level of documentation, which adds to the complication of your planning on what you want to do and what you want to achieve. You should obviously take tax advice and respect that as well. The other thing to consider is the practicalities involved with this. So, if it's a trading business, you may already have customers, suppliers, employees, all of which you would need to liaise with to achieve the transfer from one entity to another.

Host: Okay.

Adam Percival: So it's not as simple as just notifying them. The terms of your trading may require actual consent from those third parties. And although this process is clearly going to be important to the individual looking to convert, trying to convince a large supplier to give consent to a transfer may not be at the top of their list and can be quite troublesome to actually achieve sometimes. And it's the practicalities they need to think of doing that at a later date as well.

Host: So it is possible, but if you can have the foresight to choose a vehicle that will last for the long term from the outset, that's where you'd hope to be.

Adam Percival: Yes, absolutely. You need to get your crystal ball out.

Host: Okay, so we've talked about businesses that are set up to make a profit. What are the options if you're looking to set up a not for profit organisation or a social enterprise?

Adam Percival: Right. There are a number of options available. One is a company limited by guarantee, so again that's its own separate legal entity with limited liability for its members. There aren't shareholders, it's just a membership cause that slightly different but does provide flexibility for that reason you do see companies seem to be guaranteed being used by residential management companies, by sports clubs where members of those setups can change and you don't want to be troubled with trying to transfer shares back and forth.

Adam Percival: The next one is interest company, which looks to establish a trade and provide benefits to the community as a whole or a specific area of the community where it wants to benefit. Another one is a cooperative society, which is a society of people, sorry, an association of people voluntarily cooperating to meet a common purpose and an economic and social cultural need.

Host: Okay.

Adam Percival: So it's very project based. Another one is, or the final one should I say is a community benefits society and that can carry on an industry business or trade for the benefit of the community generally. So with all of those, it depends on as to which one you select, depends on again, what you're trying to achieve and whether there's a specific target aim or section of the community you're looking to benefit.

Host: Okay, there are lots of options there.

Adam Percival: Yes.

Host: Great. Thank you Adam. So what should anyone who's listened to this podcast who wants more information on setting up a business do?

Adam Percival: They can either contact me or another member of the corporate team and we can give you a stare through some of the aspects that we've discussed.

Host: Excellent. Thank you very much.

Adam Percival: Okay, no problem.

Host: Thank you for listening to straight talking business success. To find out more about the series, please visit gateleyplc.com/businesssuccess. From here, you can subscribe for updates, meet our speakers, and get more information on all of the topics that we've covered.

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