The Consquences of Choosing the Wrong Legal Business Structure For Your Franchise

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Business Structure

It’s very important that you choose the right legal business structure for your franchise. In this article we consider why this is the case and highlight four of the main consequences of picking the wrong one.

Selecting the best legal business structure is a big decision for a franchisee. As well as it impacting your legal obligations and tax implications, it also affects how your franchise operates and your profits. You need to spend time choosing the right legal business structure for your franchise so you get it right from the very start. It needs to be determined well before you sign the franchise agreement.

It’s a good idea to check out the pros and cons of different franchise business structures before settling. However, there’s no one-size-fits-all option For example, if you run a part time franchise from home you probably won’t need to form a limited company. Either way, make sure that you discuss your options with a franchise lawyer, as you might have overlooked a legal business structure that could help you out (by cutting your tax bill, for example)

Whatever you choose, it’s important you’ve considered all of the potential issues before going ahead. If not, you could run into real problems that threaten the success, or even the survival, of your business.

The consequences of choosing the wrong legal business structure

We now look at four consequences of not taking the right path from the beginning. We will mention S-corporations, which is a legal business structure used in the US. It is a corporation that elects to pass corporate income, losses, credits and deductions through to their shareholders for tax purposes.

If you want to read more about the main legal structures we use this side of the pond, you can find their descriptions in the ‘pros and cons’ article we mentioned earlier.

1. Personal liability issues

It’s hardly surprising that personal liability is a big concern among new franchisees in the UK. Lots of business owners start out operating as a sole trader, meaning there’s no legal distinction between themselves and their business. In the long-term, though, this strategy could really put you at risk.

Therefore, if you are concerned about being personally liable for any company debts, this probably isn’t the best option for you. However, some business owners thrive under this legal structure and enjoy its low cost and ease. Just make sure you have fully considered what you’re singing up for. If you choose the wrong legal business structure for your franchise, you are exposing yourself to personal liability.

2. Run into legal issues

If you don’t make the right decision about your business structure, you could find yourself on the wrong side of the law. This could range from tax issues to end of year reporting compliance, which can result in hefty fines and even prison time. You need to make sure you’re prepared to take on the responsibilities of your chosen business structure, and also have the resources to do so, to stay compliant and content.

If you discover that you have chosen the wrong business structure you need to get advice from a legal expert straight away. It’s best to address any issues as soon as possible to stop any issues rearing their head later down the line.

3. You may limit investment opportunities

If one of your goals is to seek venture capital (a form of private equity and financing that investors provide start ups that they think have long-term growth potential) on your investment, it’s more important than ever that you select the right business structure.

For instance, if you form a S-Corporation in the US, you aren’t allowed to own equity, have over one hundred shareholders or any foreign owners. Therefore, if you’re not careful, your choice of legal business structure can seriously limit your options when it comes to outside investment and membership.

4. You won’t get the most beneficial tax treatment for you

Tax treatment is high up on the list when it comes to choosing the business structure for your franchise. Each of the different models has varying rules regarding taxes and how you pay them. For example, as a sole trader, you don’t get any of the tax benefits of employing people or running a profitable business.

However, with a limited liability company, you are in a better position from a tax perspective, as you can take part of your payment as dividends. Make sure to fully investigate how you want your franchise to pay taxes and find the best suited option.

A summary of your options

1. Sole trader – this is your simplest option as it involves no formalities.
2. Partnership – if there is more than one person involved in the franchise business you would need to choose this option.
3. Limited Company – this is the most complex option and you need to register with Companies House. This structure can be expensive when it comes to set-up and continuing costs.

With regard to which legal business structure is best, you need to ask yourself how important it is that you have limited liability in terms of tax, third parties and set-up costs. Make sure to get tax advice from a legal expert, but it is generally considered that if your franchise is going to be making substantial profits, turning it into a legal entity separate from yourself is a good choice.

Choose the right legal business structure for your franchise

Picking the right legal business structure for your franchise should not be taken lightly. As there are a number of options to consider, it can be difficult to understand which is the best choice for you. Some new franchisees are so excited to get their new business up and running that they rush this important step and don’t carry out thorough research into their options.

To prevent you having any regrets further down the line, it’s strongly recommended that you consult a franchise lawyer and conduct a deep analysis into the different structures. A legal expert can give you advice on the best option for the type of franchise that you are going to run.

If you’re yet to choose a franchise, check out our UK franchise directory for the top opportunities in your area.

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