In this article
The term ‘unincorporated business’ may not seem relevant to most. However, it’s important for businesspeople to know the meaning as this may affect their liability.
In this article, we’ll be looking at what it means to run an unincorporated business. This includes the types of businesses that fall under said category and how to identify them.
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What is the difference between an incorporated business and an unincorporated business?
Every type of business in the UK falls into one of two categories: incorporated or unincorporated businesses.
An incorporated business has a separate legal personality. This detaches itself from the shareholders (owners) and directors (managers). Having a separate legal personality means that individuals are not generally liable for the business’s debts.
Unincorporated businesses do not have a separate legal personality. This is because those who run the business have not completed the legal formalities to do so. The lack of separation means the owners of the business are responsible (or liable) for its debts.
This may suggest that all businesses should logically be incorporated to protect the owners. However, various factors can affect the decision about what type of company to own.
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Sole traders.
Sole traders are the most common type of unincorporated business, and business, in the UK. Sole traders are people who individually own a business and have not incorporated it.
They are self-employed people who sell their products or services on the market. Even the neighbour’s teenager who babysits your children or cuts your grass for money is acting as a sole trader.
As a self-employed person, sole traders are liable for income tax. However, you are probably paying the teenager in cash, which not enough to meet the income tax threshold!
We have no legislation in the UK that focuses on regulating sole traders. However, this does not mean sole traders are not governed by a variety of trade, contract and business laws. Additionally, they are still governed by income tax laws due to their self-employed status.
Sole traders and liability.
As an unincorporated business, sole traders are liable for the business’s debts. There is no separation between the business’s assets and the sole trader’s personal assets because they are all held in their name.
Here’s an example:
Your friend is the owner of a café. They have not incorporated their business, and the building lease is in their name. This means they are running the business as a sole trader.
If the café starts losing business and cannot pay the rent it owes, then the landlord may take legal action against the owner. In this case, the legal action is successful and the landlord proceeds with enforcing the debt.
However, let’s say that the business assets are not enough to cover the debt. In this situation, the landlord could look to the owner’s other assets, such as money in a bank account or their interest in a property, to settle the debt. In extreme cases, it could result in the sole trader becoming bankrupt.
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Partnerships.
A partnership is another form of unincorporated business. The difference between a sole trader and a partnership is mainly having more than one owner. Moreover, partnerships have dedicated legislation: the Partnership Act 1890 (‘PA’).
Under the PA, two or more people form a partnership when ‘carrying on a business in common with a view of profit’. If two of your friends own a café and the lease was in both of their names, then they are likely in a partnership.
There are also other forms of partnerships: limited partnerships and limited liability partnerships. These have different features from a general partnership, which we discuss here.
Partnerships and liability.
A partnership as an unincorporated business is also not a separate legal entity. This means the partners share profits and are personally liable for the business’s debts.
There may be business assets that the members of the partnership equally use. For example, the kitchen equipment at a café. However, these are not owned by the partnership and one of the members will own the asset in their personal capacity.
Similarly to sole traders, the partners are self-employed and liable to pay income tax on their share of the business’s profits. In some rare situations, one of the partners is a company and will be liable for corporation tax instead.
Partners own the business, so they are not employees of the company. If the café hires a waiter under an employment contract and pays them a salary, then they are not partners – the waiters are employees. They would not share in the profits but would also not be personally liable for the business’s debts.
A PA provides a default agreement for the relationship between the partners. To change this, the partners must instead enter into a partnership agreement to add and remove rules as deemed fit.
For example, the PA’s default agreement implies that partners are to share profits equally. This disregards the input of time, money and resources of all partners. Partners can remove such a rule within a partnership agreement, which is important when considering levels of input.
Limited partnerships.
Although Limited Partnership (“LPs”) are not widely recognised, there are over 49,000 of them in the UK. They share similarities to a partnership in that at least one of the partners must be personally liable for the business’s debts. Because of this, it retains this key element of an unincorporated business.
However, LPs will limit the liabilities of at least one partner to the amount they originally invested in the business. This goes all the way back to when they became a partner.
There are also some key conditions for the partner’s liability to remain limited:
- They must not have control and manage the LP;
- They must not have ultimate discretion on the decision-making of the LP; or
- They must not withdraw their initial contribution from the LP as long as the LP is trading.
This is generally used when someone invests capital or resources in the business in exchange for a share in the business profits. They will also have no involvement in the business. Partners lose their limited liability status if they breach these conditions, meaning they now share in the liability of other partners.
Limited partnerships have become rarer in recent years alongside unincorporated businesses. This is due to incorporated businesses offering more protection for all the owners.
How can Britton and Time Solicitors help?
When it comes to setting up your unincorporated business, it’s important to stay within the lines of the law. With our initial consultation, we can provide you with:
- Unlimited time to go through the details of your business and ask any questions you may have
- An overview of your legal standpoint and your available options
- A precise time and fee estimate for your matter
To arrange your initial consultation with one of our solicitors, simply call us on 020 3007 5500.
Dear Sir,
When you say in you page
https://brittontime.com/2023/03/07/types-of-business-unincorporated-business/
that in incorporated company the owner detach himself from any liability.
Please correct me of if I am wrong, total liabilities of a LLC companies is limited to paid up capital of the company. Therefore unincorporated company such as LLC can be a good solution by not a corporate entity but limit the liability to initial investments.
Appreciate if you explain the LLC companies and how they are different from incorporation.