For the founders of new companies, it can be difficult to know how best to structure a business. To help you choose the right option, here’s a simple guide to the differences between a sole trader and a limited company.
What is a sole trader?
A sole trader is someone who is self-employed and the sole owner of a business. It’s the simplest business structure to set up, and the most popular choice for the self-employed. 60% of small businesses operate as sole traders. According to government figures, at the beginning of 2019 around 3.5 million businesses were operating as sole traders.
You can set up as a sole trader through the government website, which is necessary for tax purposes.
What is a limited company?
A limited company is a legal entity in its own right. Unlike a sole trader, a limited company has its own legal identity which is separate from its shareholders or directors. This is true whether the limited company is run and operated by one person or many.
Setting up as a limited company is the second most popular structure for UK businesses. At the beginning of 2019 there were 1.9 million registered limited companies operating in the UK.
Sole trader vs. limited company
There are pros and cons for each legal structure and while being a sole trader is perhaps the simplest way to get your business up and running, there are also disadvantages. Let’s take a closer look at the advantages of each, followed by the disadvantages.
Advantages of being a sole trader
- Simplicity: Set up is quick and easy with relatively little paperwork required. Once established, you will need to complete an annual self-assessment tax return.
- Privacy: Your business doesn’t have to register with Companies House.
Disadvantages of being a sole trader
- Unlimited liability: Sole traders are not viewed as a separate entity so, if the business has financial problems and runs into debt, the business owner is liable and could lose personal assets
- Difficult to raise finance: Banks and investors tend to prefer limited company structures so it may be more difficult to raise finance, which could limit the potential for business growth.
- High tax: HMRC treat business and personal income and expenditures as one so, once your business reaches a certain level of financial success, a limited company structure may prove more tax efficient.
Advantages of being a limited company
- Limited liability: The legal distinction between you and your business means your personal finances and assets are protected in the event that your business runs into financial difficulties.
- Tax incentives: Limited companies generally prove to be more tax efficient since you pay Corporation Tax on profits rather than Income Tax. The rate of tax is dependent on how much profit your company makes. As well as allowing tax-deductible costs, you can also claim a wider range of allowances.
- Registered business name: Once your company name has been registered, no one else can claim it.
- Credible presence: Being a limited company comes with a certain level of prestige and trust, which gives you advantages you may not have as a sole trader.
Disadvantages of being a limited company
- More responsibility: Along with the additional paperwork, in the form of annual tax returns and annual accounts, limited company directors must conform to the Director’s Fiduciary Responsibilities which incorporates all the legal requirements for what a company director must legally do.
- Time-consuming: The extra paperwork and tax reporting can end up being more expensive and time-consuming, often requiring expert help from an accountant. There is also an initial upfront fee to form a limited company.
- Less privacy: Details of limited companies are listed with Companies House, and include details about directors as well as all the company earnings. For some, this transparency can be off-putting.
Before deciding which legal structure is best for your business, it’s important to weigh up all the differences between operating as a sole trader and forming a limited company. Which structure is most suitable will come down to you, your business and your specific situation.
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