It seems that most articles now are focused on the problems people and businesses are facing, caused by COVID-19. We have recently published articles on force majeure and frustration, for example. Clearly, it is a very difficult time for businesses but previous economic hard times have taught us that for some the adversity is just the push they needed to change tack and set out on their own.
If you have an idea or a skill-set you feel would translate into a business, there are a few things that you should consider right at the start. If you are setting up with a partner, it is the best time to agree what will happen if things go wrong, or very right, because you will be able to lean on the goodwill and optimism. Getting to the stage where you can start actually running your business is a two-stage process.
The first thing to think about is how you are going to operate your business. Each option has its pros and cons and you should be able to find the right fit for you. Generally, the trade-offs are between the amount you could be personally liable for and the cost and formalities of operating. Four popular options, in what should be an obviously-logical order:
- Sole trader. This is the simplest, cheapest and quickest structure, but offers little protection from liabilities. You are simply trading on your own account. It is only suitable for (as the name suggests) single-person businesses and should only be used for the smallest undertakings. If you chose this structure it would be your name on the contracts and it is your name on the bank accounts, so if it goes wrong you are personally liable for the losses.
- If you have a business partner then this is the simplest structure. A partnership is formed where two or more people carry on business together with the aim of generating a profit. There are rules for partnerships set out in the Partnership Act 1890 which, thankfully for a 130 year old statute, allow the partners to agree to amend. The partners hold the property and sign the contracts for the partnership and they can be held liable for the partnership’s debts.
- Limited Liability Partnership. This is a partnership which provides the partners with protection from the partnership’s debts (limited liability), known as LLPs. LLPs were introduced in 2000 as a way of joining the benefits of a partnership and a limited company (below). The trade off for limiting your liability is that you will have to make more information about your business public, for example its finances. LLPs must follow the rules in the Companies Act 2006.
- Limited Company. There are many types of limited company, but the most appropriate here is the company limited by shares. The company is owned by its shareholders (known as members) and ran day-to-day by its directors. The company itself is a separate legal entity, meaning it can enter into contracts in its own name, own property and sue and be sued. The shareholders’ liability is limited to the amount unpaid on their shares (in reality, if it all goes wrong the shareholders just lose the company) and the directors are subject to strict rules on how they run the business. Limited companies have to make information public, such as their accounts, the names of their directors and shareholders with ‘significant control’.
There are other options for more niche organisations, such as not-for-profits or community organisations. If you are thinking about setting up something like this, we would be happy to discuss.
In practice it is not quite so clear cut. For example, if your business requires borrowed finance the lender will probably insist on a personal guarantee. This means that you (or whoever the gives the guarantee) will remain liable for the loan if the business does not repay. Company directors are also not free to run the company however they chose, there are rules about trading when debts are likely to not be able to be repaid and the sanctions could include a ban on being a director in the future.
The decision on which vehicle to use to run your company will need to consider both the legal structure and framework and potential tax implications. It is important to take proper advice on both as early as possible to avoid problems down the line.
The second stage is to then properly set up your business. If you are a sole trader the options are minimal, but the other three have potential to tailor arrangements to your needs; this is done through the constitutional documents.
A partnership or LLP is governed by a partnership agreement. This sets out everything from how the profits will be split, how much holiday time the partners can take, what happens when the partnership is dissolved, if and how new partners can join, and almost everything else in between. It is essentially a contract between the partners which regulates how they will run the partnership. They can be quite long documents and there may be many decisions to take about how things will operate but a properly drafted partnership agreement can save a business if there is a dispute, or even stop a dispute from happening.
For traditional partnerships it is not necessary to have a partnership agreement, just that the partners are in business together for profit. If there is no agreement the partnership is governed by the default provisions in the Partnership Act 1890, which can be quite strict and arcane. Business practices have moved on somewhat in the past near century-and-a-half.
Limited companies have Articles of Association as their constitutional documents. There are default articles published by the government (the ‘Model Articles’) which will suffice for many companies. There is the possibility to amend the model articles to better suit, which can be very useful. You could, for example, require a different proportion for a vote to pass, or deal with conflicts of interest.
Articles of association have three main limitations:
- They need to be compliant with the Companies Act 2006, which stipulates some minimum standards below which the parties cannot agree to go. Depending on what you want to do, this could be a big sticking point.
- They operate between the company and each member, not between the members. This means they are of limited use for a member to try to regulate how another member acts.
- They can be changed if members holding 75% or more of the shares agree to change them.
To get around these restrictions you could enter into a Shareholders’ Agreement. These bind the members and operate between the members. They are not subject to the same Companies Act restrictions and the parties can agree a different mechanism for changing the terms.
Shareholder’s agreements cover a diverse range of situations. Some common examples are to set out what happens if another company offers to take over your company, what happens if someone wants to sell their shares and a mechanism for requiring someone to sell their shares if they act in bad faith towards the company. They are very powerful and extremely useful to have. The first question most solicitors ask when there is a dispute between the shareholders is: “do you have a shareholders’ agreement?” Again, they can be quite a long document but they may just save your business.
Now you can focus on your business, secure in the knowledge that you are operating with the right structure and you have agreed the terms of your business relationship with any partners. You are well set to move forward, reap the rewards and weather any storms.
If you would like to speak to someone about any of the issues above, please contact David Artley at email@example.com or Tony Wentworth at firstname.lastname@example.org or call 01642 356500/0191 2322574.
David Artley, Solicitor, Company and Commercial Team, Jacksons Law Firm