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Deciding whether to start your business up as a sole trader or push forward with a limited company is a big decision, and one that shouldn’t be rushed. Here we provide you with some key information to ensure you choose the right legal structure for you and your small business.
What is a sole trader?
A sole trader is an individual who is self-employed and running their business as the sole owner. There is no distinction between the person operating as a sole trader and their business, they are the same legal identity.
Sole trader businesses are not registered as actual businesses. Instead, the individual who wishes to be set up as a sole trader needs to register with HMRC as self-employed.
The sole trader business model is currently the most popular structure in the UK.
What is a limited company?
A limited company is a business model where the owners (known as members or shareholders) are a separate legal entity from the business. There is a clear distinction between the person or people involved in the business and the actual business.
There are several types of limited companies, including private limited by shares (LTD), private limited by guarantee (also LTD), limited liability partnerships (LLP), public limited companies (PLC), and private unlimited companies. All of these must be registered at Companies House, the UK’s official registrar of companies.
The limited company structure is the second most popular business model in the UK, with private companies limited by shares being the most popular type of limited company.
So that’s a brief synopsis of the two main structures, but what are the advantages and disadvantages of each? Let’s take a look.
Advantages to running your business as a sole trader
If you decide to set up as a sole trader, you will be able to:
Get started now – You are considered a sole trader from the moment you start trading. You must register with HMRC as self-employed as soon as possible after trading activity has taken place, but there is no requirement to have any dealings with Companies House.
Focus on your business – There’s very little admin involved with running as a sole trader, with your only real filing requirement being to send in an annual Self Assessment tax return. This is good news if your skillset does not extend to administrative duties.
Pay yourself when you want – Because there’s no distinction between you and your business, you can remove money from it as and when you need to, assuming enough money is left in the bank to pay tax and other bills.
Navigate through a tricky first year – It’s normal for a small business to take a while to get off the ground. If your first year in business is financially challenging, you will have options to set business losses against other income streams.
Do business in relative privacy – Your business’s financial records will not be published anywhere. Generally, the only information that’s made public is what you want ‘out there’ for marketing purposes.
Disadvantages to running your business as a sole trader
However, as a sole trader, you will find that:
Your finances are at risk – This is the big one. Because there is no distinction between you and the business, if your business were to accrue debts (or be sued), you may be required to use your personal assets to pay these off.
It isn’t always tax efficient – This depends a great deal on particular circumstances, but generally speaking, the model is not associated with tax efficiency. If you do experience business success, it’s likely you will end up registering as a limited company.
Raising capital can be a challenge – Securing financing (such as a loan) isn’t always easy, because the structure does not provide full financial transparency. Also, because, a sole trader can’t offer investors a stake in the business through shares, investment isn’t always forthcoming as investors see no tangible reward.
Your professionalism is questioned – Unfortunately (and unfairly), the structure can sometimes be perceived as unprofessional. This can pose problems when it comes to winning contracts, as some organisations would prefer to work with the more esteemed limited company structure.
There’s no clear route for succession – The business is essentially you. This means, if you choose to hand over the reins, you will find it harder when compared to a limited company.
Advantages to running your business as a limited company
If you decide to form a limited company, you will be able to:
Protect your personal finances – The shareholders of a limited company are only liable for the unpaid nominal value of their shares. This means if debts are accrued, their personal assets are protected.
Be tax efficient – This depends on your circumstances, but on the whole, the limited company structure is a more tax efficient business model when compared to a sole trader.
Reap the benefits of an esteemed structure – If put up against a like-for-like business that’s operating as a sole trader, lenders, investors, and potential clients are more likely to work with you, because of the professional image a limited company projects.
Implement succession – A limited company is a separate legal entity from that of the person or people who formed it. It is common for shareholders to come and go. If you decide to step down, passing the company on is a relatively simple process.
Safeguard your company name – When you form a limited company, this prevents anyone else from forming another company with your company name (or a name that’s even similar to yours). The sole trader model does not provide any level of name protection.
Disadvantages to running your business as a limited company
If you decide to form a limited company, you will notice that:
Assistance may be required with the formation process – Typically, registering a limited company with Companies House isn’t quite as easy as registering as self-employed with HMRC. However, if you allow us to help you via any of our company formation packages, you will find the online process quick and simple (companies are generally registered within 3 to 6 working hours).
There is admin required – To operate a limited company, you must file an annual confirmation statement, annual accounts and a tax return. You must also ensure that you pay corporation tax on time, keep the company’s records and registers up to date, and notify Companies House of any changes to your company. If this sounds like a burden, don’t worry – we can provide assistance through our Full Company Secretary Service.
Directors have legal duties – The directors of a limited company (the people tasked with the day-to-day running of the business) have numerous roles and responsibilities, including taking care of everything mentioned in the above admin section. Directors who do not meet the necessary requirements can suffer legal consequences, including fines and in severe cases, imprisonment.
Company information is made publicly available – To enhance trust in the limited company structure, information about a company, including its directors, shareholders, and finances is made freely available on the Companies House public register. Whilst you can protect certain information, such as residential addresses, with our Registered Office Address and Service Address services – having other information made publicly available (such as director and shareholder names) is unavoidable.
Paying yourself isn’t quite as simple – You can’t just withdraw money from the company’s bank account as and when you need it. Whilst there are a number of ways money can be taken out – including a director’s salary, dividend payments, a director’s loan, and expenses – these all require a correct procedure that must be followed.
Sole trader or limited company – making your decision
No two businesses are the same, and the model that’s right for you and your small business will obviously depend on your circumstances.
As highlighted in the post, both structures have strengths and weaknesses. If you feel the responsibilities of a limited company will initially be too much of a burden, perhaps you should test the waters as a sole trader – although we must stress that we can provide assistance through our range of company secretarial services.
However, if you’re ready to make a go of it, and want financial protection and tax efficiency, we recommend taking the limited company route.
So there you have it
We hope you have found this post helpful in choosing between the sole trader and limited company structures. If you have any questions, please leave a comment on this post and we’ll get back to you as soon as possible.
Finally, if you have decided that a limited company is right for you, we offer a number of company formation packages designed to get your business off the ground in a matter of hours. Prices start from £12.99.
Thanks for reading.