Running your franchise within the right business structure is not just a matter of paperwork – it has the potential to affect your personal life, too. Choosing the right business structure is all about limiting the liability and maintaining control.
Disclaimer: The information in this post does not constitute legal advice.
Franchising is perhaps the most popular business model, especially among consumer-facing businesses. The UK franchising sector has grown at 10% in the last four years – a period when the national economy struggled to break past the coveted 1.5% mark.
There are multiple reasons to this fascinating growth (and unbounded potential). The most prominent reason is the willingness of successful businesses to open up their operations to outsiders. Franchising allows businesses to expand – at someone else’s expense. On the other hand, it allows franchisees – most of whom are first-time business owners – to leverage a business plan that has been proven to work.
Given this massive appeal, it’s no wonder that more and more people are willing to try their hand at buying franchises. When the business know-how is served in a ready-to-deploy package, it’s easy to forget the basics.
One such basic factor is the business structure. There is widespread confusion among franchisees about which structure best fits the franchising model. In this post, we will try to clear the air by comparing all the options.
Before getting to this point, let’s take a moment to understand the franchisor-franchisee relationship – a vital link (legally, financially as well as professionally) that not a lot of franchisees take into account.
The Franchisor-Franchisee Relationship
When it comes to franchising, there are numerous misconceptions out there that make life difficult for franchisees. It all starts right here, with not knowing exactly what their position is in the whole game.
It’s simple – don’t let anyone complicate this for you.
As a franchisee, you will have a purely contractual professional relationship with the franchisor. You will never ‘work for the franchisor’, nor will you ever be ‘paid by them’. You will generate revenue on your own, through the assistance provided by the franchisor. Depending on the contract you have in place (the Franchise Agreement), you will either pay ongoing royalties or commissions to the franchisor, in addition to all other expense components.
So, it should now be clear that running a franchise business is exactly what it says it is. Of course, you will never have the sort of freedom that comes with setting up your very own business from the scratch, but that’s the price you have to pay to fast-track the growth with the help of the franchisor who can offer a well-oiled, ready-to-roll business plan.
If you haven’t already, we would urge you to go through our free franchising guides. They are an excellent repository of all-things-franchising and are updated on a regular basis.
Recommended: 4 Reasons Why Franchising Is Here to Stay in the UK
What Is The Business Structure? Why Should A Franchise Business Care About It?
The business structure is one of the most fundamental identities attached to any business. In many cases, you’ll see it being referred to as the ‘legal structure’ of the business.
“Almost every major legal and financial development that takes place within a business is dictated by its legal structure. So, there’s every reason for you to be careful – about the present and more so about the future – when framing your business within a particular business structure.”
To give you an idea, here are some things that the business structure has directly impacts:
How You Get Started
Quite a few entrepreneurs are put off by the idea of having to deal with a whole lot of paperwork when starting a new business. To be fair, it can get quite overwhelming – but it pays to get done with it the right way.
The paperwork involved in the process will vary based solely on the business structure you choose to go with. In addition, the permissions, licences and clearances you will require from various authorities will also depend on the business structure.
Raising the Capital
On our UK franchising blog, we regularly talk about how franchisees can raise money to get their business up and running. It’s a difficult enough process to start with – there’s no point in making it even more frustrating by choosing the wrong business structure.
Most lenders will refer to the trading history and credit scores before they decide on your loan applications. What they will refer to will, in this case, be determined by the business structure you choose.
Handling the Profits
There are many ways people choose to get paid from their business activities. Some take a regular, monthly paycheque, and others go for selling their equity. Some go so far as to putting in place elaborate profit-sharing contracts among all the partners.
As you can imagine, the kind of legal control you hold over the company will eventually dictate all these decisions. In other words, the business structure will be the sole factor that will decide how you get paid. Perhaps the most compelling reason to think the decision through!
Dealing with the Taxman
Franchise businesses are often found wanting when it comes to being ‘tax ready’.
Our experience tells us that there’s a common reason behind every such story – the lack of experience in running a business.
If you don’t quite know about the kind of taxes franchises are required to pay, we have it all put together for you in this free UK Franchise Taxation Guide.
The types of taxes your franchise business will need to pay (and the amounts, in most cases) will depend, again, on the business structure you choose. What’s more, your personal taxes will also depend upon how you got paid in the first place (the point we made earlier).
Managing the Liability (Very Important!)
Running a business has its risks – and these aren’t always strictly financial.
Any liability that arises directly from your business operations – legal and financial – will be a direct function of the way the business is set up (i.e. the business structure). If the business, unfortunately, has to face bad debt scenarios, the business structure will decide how the liability is shared. Similarly, if there are any legal proceedings against the business, the business structure will dictate how the ramifications are addressed.
Types of Franchise Business Structures in the UK
There are no systemic distinctions between regular businesses and ‘franchise’ businesses.
So, the types of franchise business structures are the same as those for other businesses. In the UK, there are 4 major types of legal structures for businesses:
1. Sole Trader
3. Limited Liability Partnership (LLP)
4. Limited Liability Company (Ltd)
We will discuss what these are and what they bring to the mix.
This is the most common starting point for franchise businesses – and justly so.
Registering a business as a sole trader is the easiest, least expensive, fastest and most straightforward way, especially when you are starting out small. Professionals – especially service providers – have been using this business structure extensively for years. In fact, close to three quarters of businesses in the UK are sole traders.
Being a sole trader allows you to bypass most business hurdles as far as decision making is concerned. You will run the business with 100% control, meaning that you will be free to drive it in any direction you see fit. There will be no partners to discuss the matters with, no boardroom meetings to worry about. You will be able to employ staff, run the business as usual and keep things simple.
What Does Registering As a Sole Trader Mean?
Registering your franchise business as a sole trader simply means that you will be working on your own and for yourself. As mentioned earlier, this does NOT mean you can’t employ staff.
Read more: Registering as a sole trader in the UK.
Advantages of Registering Your Franchise As a Sole Trader
- There are no lengthy procedures or no cumbersome red tape involved.
- Registering does not cost you any money.
- The process is quick – within a week of registering (or thereabouts), you will have your registration details (most importantly, the Unique Tax Reference Number, UTR).
- Registering a business as a sole trader allows you to register the business name, too.
- Most business expenses – from phone bills to business travels – will be tax deductible.
Disadvantages of Registering Your Franchise As a Sole Trader
- The biggest disadvantage is the liability – you and your business will be virtually indistinguishable. You will personally be liable for all the business debts.
- As an extension of this liability, your personal finances are exposed to business risks. In essence, being a sole trader means you expose your house, your other assets and the wellbeing of your family to all these risks.
- As a sole trader, you will rarely get any tax benefits of running a successful business or employing people.
- All business profits will be taxed as income. Being ‘self-employed’, you will need to follow the self-assessment procedures as usual.
- Raising finances as a sole trader isn’t much different from borrowing money in your personal capacity. So, your personal credit history will always be at the focal point.
- Even though sole traders can choose business names, these names aren’t available for general public to look up. Two or more sole traders can share the same name.
- Since you assume the full control of the business, the business can come to a virtual standstill in unfortunate events such as your hospitalisation or death.
When Should You Register Your Franchise Business As a Sole Trader?
You should consider registering your franchise business as a sole trader when and if:
- You are starting out with little capital and don’t expect to raise heavy loans any time soon.
- You want to get your franchise business up and running quickly.
- You are comfortable with the liability that comes with this option.
- You want to retain the full control of the business.
A business partnership is an extension of the sole trader business structure.
Essentially, it’s a business structure where multiple sole traders assume the charge with the liability being shared between them.
A good example of this is a business run by a husband and wife. They can both register as ‘self-employed’ and form a business partnership with unlimited liability without much paperwork.
What Does Forming a Business Partnership Mean?
Registering your franchise business as a business partnership means that you put together a framework that decides the level of control, authority and profit sharing between multiple partners. Needless to say, you need to be very careful about your business partners. Thanks to the unlimited liability, their actions can hurt your personal and business prospects.
Advantages of Registering Your Franchise Business As a Partnership
- Like being a sole trader, registering a business partnership is fairly easy and quick.
- Thanks to multiple partners, the capital raising prospects of your business grow proportionately higher. All partners can help raise finances towards common business goals.
- Having access to multiple points of view is incredibly helpful – especially if partners bring on board great expertise in various fields.
- The responsibility of running the franchise can be shared between partners. In one partner’s absence, others can take over without much hassle.
Disadvantages of Registering Your Franchise Business As a Partnership
- Forming a thoroughly-thought-through partnership agreement is enormously important – a step many new businesses can’t seem to get right.
- The liability is unlimited, meaning that any and every business debt will be the shared liability of ALL partners.
- All partners are required to submit individual self-assessments to the HMRC.
- All shared profits will be taxed as ‘income’.
- Disagreements, loss of trust and many other ‘rapport’ problems can lead to standoffs that can paralyse business operations.
When Should You Register Your Business As a Partnership?
You should consider forming a business partnership to run your franchise business if and when:
- You need to raise more capital to start off.
- You have reliable business partners.
- You want to eventually grow the business to a ‘company’ level.
Limited Liability Partnership (LLP)
Just as business partnerships are an extension of the sole trading structure, limited liability partnerships are an extension of partnerships.
LLPs have been enjoying some new-found love from business across the UK, thanks to the combination of flexibility and safety they offer to business owners.
What Does Forming a Limited Liability Partnership (LLP) Mean?
An LLP is formed between multiple business partners the same way as business partnerships are formed. This involves setting up an elaborate partnership agreement that stipulates the profit and responsibility sharing details. Each limited partner is required to register with the HMRC as ‘self-employed’, while the business itself needs to be registered with the Companies House.
The key difference is that within an LLP, the liability of partners is limited (usually to their share of investments in the company).
Advantages of Registering Your Franchise Business As an LLP
- The most obvious advantage is the limited liability. Partners share the liability that is proportionate to their investments and involvement in the company. This greatly reduces your exposure to debt recoveries and other legal troubles.
- There is no limit to the number of partners you can have in an LLP.
- You won’t be (fully) liable for the actions of other partners.
- LLPs combine the best features of partnerships and corporates.
- The tax burden lies on individual partners. This can give your business an edge in the long run.
Disadvantages of Registering Your Franchise Business As an LLP
- All financials are to be submitted to the Companies House. These will be available in the public domain. For a small business, the public disclosure rarely makes much sense.
- More paperwork, more regulatory control.
- Like partnerships, LLPs are dissolved when all but one partner decide to exit.
- To form an LLP, you need to choose a business name that isn’t already taken by other companies.
When Should You Register Your Franchise Business As an LLP?
You should consider choosing a limited liability partnership structure for your franchise business over other options when and if:
- You plan on bringing on board many partners.
- You need to raise multiple loans.
- You need to limit your exposure to legal and financial liabilities. This applies particularly to franchise businesses in high-risk consumer facing categories like pest control.
Limited Liability Company (Ltd)
Since most franchise businesses don’t really go so far as incorporating a limited liability company (private limited company), we’ll keep this segment short.
What Does Incorporating a Limited Liability Company (Ltd) Mean?
Incorporating a limited liability company means registering a ‘full-fledged’ company with the Companies House. Usually, this is a move that best suits medium to large sized businesses with multiple shareholders.
Read more: Incorporating a private limited company.
Advantages of Registering a Business As a Private Limited Company
- Limited liability (limited by shares)
- Robust operations
- Higher capital raising potential
- More trust and credibility
- Better tax management
Disadvantages of Registering a Business As a Private Limited Company
- More expensive
- High regulation and public disclosure
- Unsuitable for small businesses
Franchise Business Structures in the UK: The Takeaways
- Choosing the correct business structure is important to safeguard your personal interests.
- It can also save you a great deal of hassle and money in the long run. In fact, choosing the wrong business structure is almost always guaranteed to cost you more.
- The initial costs should never outweigh long term interests.
- Always consult with an experienced, qualified professional before finalising the business structure.
Have any questions or comments? Feel free to drop us a line!