As a legal firm which offers legal services for SMEs, we are often tasked with helping to set up new SMEs. We also assist growing businesses.

You will want to manage risk and ensure a smooth ride even when relationships between founders hit a rocky patch. So here are some tips about the optimal choice of legal structure to adopt.

How do you structure an SME?

First and foremost, choose a tried and tested structure for your business: a Companies Act company limited by shares.

Even if you are a sole trader, it’s a good idea to protect yourself from the risk of personal liability. Trading as an individual always gives rise to such risk. If there are several founders, don’t be tempted to create a simple partnership. This is no more than a group of people in business with a view to a common profit.

That ‘structure’ does not create a separate legal personality. Thus, it exposes all of the founders to potential personal liability in the course of trading. There is a legal form of limited liability partnership (known colloquially as an LLP). However, this is a more complex model to operate. It is better suited to professional services provision.

Adopting a new corporate structure

Perhaps reading this, you are already in business without any such corporate protection. If so, don’t worry. Everything is rosy and relationships are good. It’s easy enough to adopt the new structure and to agree on mutual protections. This is advisable in case things don’t progress as expected.

So, the great advantage of a corporate structure is that it has a separate legal personality with limited liability status. This means that, apart from any wrongdoing, individuals involved do not incur personal liability in connection with the business’s obligations. For these purposes, ‘wrongdoing’ is likely confined to acting dishonestly or fraudulently. It also includes continuing to trade when the business is insolvent.

Who owns an SME?

In case you are not familiar, with the internal bones of a company limited by shares, there are two types of roles involved:

(1) directors, who are either executive or non-executive but who collectively are responsible for the day-to-day management and administration of the company.

(2) shareholders: whose legal rights focus on trying to ensure that the directors make the company profitable. The shareholders might be external third-party investors (corporates or individuals). They have provided working capital for the company. Alternatively, they might simply be the directors, who may or may not have invested funds.

The basic ‘rules’ of operation of the company, and the roles of director and shareholder, are set out in the company’s constitution called Articles of Association. These are supplemented by company law. Typically, when a business is being set up by individuals, to keep costs down, the individuals will set up a private limited company (at Companies House) using Model Articles. This is the ‘standard’ form of corporate constitution for a private limited liability company.

The problem is that this may be false economy. That’s because Model Articles are not designed to cater for the specific requirements of individual shareholders. They treat the shareholders as one class together. Furthermore, they assume decision making is by simple majority of shareholder votes. In relation to more material matters, as dictated by corporate law, a 75% majority is required.

In practice, arrangements about shareholder rights and profit sharing often need to be more complex than everyone sharing everything equally. For see our article ‘The role of shareholders in an SME’.

Setting up a new SME

Setting up a new SME or restructing an exisiting business can be more complex that you may think. Ensuring you get it right at the start will give you the strongest foundations to build upon.