Setting up a business – choosing the best structure: self-employed, not-for-profit company, or commercial enterprise?

Businesses and organisations in the creative and cultural sector are set up with different legal structures; we need to be aware of the options available and the consequences of each.

A creative entrepreneur can operate as a self-employed ‘sole trader’, in a partnership, or set up a separate legal entity such as a company for the purposes of running a business. Self-employment, a commercial company, a partnership, a ‘not-for-profit’ company, a social enterprise or a charity are all possible and there are many examples of creative businesses and organisations set up in each of these ways.

Each of these structures has ‘pros and cons’ so it’s useful to examine all the options and be aware of the advantages and disadvantages of each. Before deciding on a particular structure, it’s advisable to consider the bigger picture and the long-term view. In particular, be aware of the consequences in terms of investment, ownership, control and reward.

For example, it might be easier to get a grant in the short term by choosing a ‘not for profit’ structure, but this same structure may prevent you from getting commercial investment in the future, and can also result in the founders losing ownership and control of their enterprise.

"Dragon's Den"

The simplest way to start is business is as a sole trader, which involves registering as self-employed with Her Majesty’s Revenue and Customs (HMRC). One of the biggest disadvantages of this arrangement is that the individual has unlimited liability for business debts since there is no legal separation between a person’s business and personal finances.

The alternative to this is a legal structure which limits the financial liability of its members to the amount they have invested or guaranteed, ie a ‘Limited Company’, either with shares (a ‘Company Limited by Shares’) or without shares (a ‘Company Limited by Guarantee without Share Capital’).

The benefits of having shares include: (1) the option to attract investment by selling shares (as we’ve seen on the Dragon’s Den TV show), (2) there can be different levels of shareholding including a majority stake, and (3) investors can be rewarded by paying them a dividend on their shares.

The ‘Company Limited by Guarantee without Share Capital’ does not have shares so there can be no payment of dividends, which means that this type of organisation can be described as ‘non-profit-distributing’, a set-up preferred by some funders such as Arts Council England.

This constitution means that profits cannot be distributed to shareholders but the company can still make a profit, so the terms ‘non-profit’ or ‘not-for-profit’ can be confusing.

The downside of this structure is that nobody can have a majority shareholding, so its members are all equal in terms of ownership and control, and any well-earned bonuses to individuals can only be paid by the less tax-efficient Pay As You Earn (PAYE) route. (By the way, the ‘Guarantee’ is a promise from each member to pay a token amount, often £10, in the event of the company winding up.)

Creative organisations operating as social enterprises can register a company (one with or without shares) as a Community Interest Company (CIC) with the CIC Regulator. This gives the company the status of a CIC with additional benefits and responsibilities.

Partnerships of two or more people in business together usually have unlimited financial liability for each of the individuals concerned, unless constituted as a Limited Liability Partnership (LLP).

Charities are registered with and regulated by the Charity Commission and charities are usually constituted firstly as companies limited by guarantee before applying for additional charity status which confers benefits and restrictions in addition to those of a limited company.

It’s relatively easy and inexpensive to set up a company, either by applying directly to Companies House link or using one of many agencies such as the online Company Wizard which will register a company for you.

Business strategy

 Of course you don’t have to choose only one structure. Entrepreneurs and organisations often have more than one legal entity.

For example a charity might also have a subsidiary trading company, a commercial organisation can have a charitable arm, and an enterprise can be built up as a group of companies, to enable different investment options, involve different people and ‘compartmentalise’ business risks.

But before choosing a legal format for your enterprise, think first about your overall business strategy and then select the most appropriate legal structure(s) to suit your purposes and achieve your goals.

Copyright © David Parrish 2009. www.davidparrish.com