When you are deciding to set up a new business, there are many things for you to consider, but one of the most important things to think about is what business structure you want to have as this will determine your legal structure. You will need to make this decision before you start running your business and it will determine how you will officially set up the business.
Most companies chose between being a sole trader or a limited company which is why we have decided to explore the differences between these two business structures in this piece. In 2019, there were 5.8 million small business in the UK, of these 3.5 million were sole traders and 1.9 million were limited companies, which makes over 60% of small businesses sole traders.
You have a choice of setting up your business as a sole trader, partnership or a limited company. A sole trader is where you operate on your own with sole ownership of the business. A partnership is where more than one person has ownership of the business, but it operates it in a similar way to a sole trader.
A limited company is a registered business that has a legal separation from its owners, shareholders and management team, and therefore this reduces the liability on those individuals involved in the business.
There are two types of limited companies which are either limited by shares or limited by guarantee. A limited by shares company is generally those that are run for profit and have shareholders in the business. A limited by guarantee company is generally those that are not-for-profit businesses and will have guarantors rather than shareholders, and profits will be reinvested into the business.
It can be difficult to decide whether to be a sole trader or limited company as there are many pros and cons on each side to think about. This is why we have created this piece on sole trader vs limited company so that it can assist you in making the decision.
If you need help see: 83 Company Formation Agents: 2020 Price Comparison
We have put together a list of all the pros and cons so that you can make an informed decision about what is most important to your business.
What are the advantages of being a sole trader?
There are many advantages of being a sole trader or being self-employed which include:
- Setting up as a sole trader is easier to do than a limited company as you will only need to register with the HMRC as self-employed for self-assessment tax return and when you do this it should also register you for National Insurance.
- You will only need to make a self-assessment tax return each year and there are no other requirements on you in regards to government reporting or financial accounting.
- You will have greater privacy for yourself and your business as your details will not be included in Companies House, unlike limited companies.
What are the advantages of being a limited company?
There are many advantages of being a limited company which include:
- By far the biggest advantage of being a limited company is that you will have a legal separation between you and the business. This means that you will not be held financially liable for the business as your personal finances are separated from the business at the point you incorporated the business. As a sole trader, this is not the case. A limited company can only be held liable on what the business owes in their own right, so in a worst-case scenario, an individual will only lose what they have invested in the business.
- Limited companies can also be more tax-efficient than sole traders as they pay Corporation Tax rather than Income Tax. Corporate Tax at present can offer better tax rates so being a limited company can reduce your tax. There are also more tax-deductible costs and allowances that can be made if you are a limited company.
- You can also pay out dividends to owners or shareholders which is more tax efficient and can give individuals a greater tax-free allowance as each person has a dividend tax allowance on top of their personal tax allowance.
- Ownership of the company can be easily divided between different people because you can determine this through the division of company shares.
- Your business can grow with you as you start to employ staff.
- As a limited company, other companies especially larger businesses and public sector organisations are more likely to contract work. This is due to the perception of your business as a limited company as you will have had checks on your business and your accounts will be publicly available making your business more transparent.
- By registering your company name with Companies House, it can prevent anyone from using the exact same company name and there would need to be a distinction between any similar name. Sole traders do not have this protection of their company name.
What are the disadvantages of being a sole trader?
As with most things, there are some disadvantages of being a sole trader which include:
- The biggest disadvantage of being a sole trader is that you will not have a legal separation from the business and you will be financially liable for your business. If the business goes into debt or is liable for their work, the owners will have unlimited liability for the business which could lead to a personal loss of assets due. For this reason, it is important to take out appropriate business insurance to cover your liabilities and to protect you and your family. We have done many reviews on different insurance products available on the market which includes specific self-employed and sole traders Although it is worth noting that you will need insurance regardless of your business structure and all business should explore their insurance requirements.
- Many sole traders can find it hard to work with large businesses or public sector organisations as their sole trader status is held against them whereas a limited company is perceived differently as they are more transparent. Many sole traders often end up changing their business to a limited company to get work from these types of businesses or will use umbrella company as the intermediary to take on the work.
- If you need to raise some finance for your business it can be harder for sole traders as investors and banks will favour limited companies which could impact the growth of your business.
- If you operate as a sole trader and have a high rate of earnings you may be worse off from a tax point as view as the tax rates may not be in your favour.
- You don’t need to register your company or the name, but this means there is no protection from someone else using the same company name as you.
What are the disadvantages of being a limited company?
There are also disadvantages of being a limited company which include:
- There are a couple of extra steps in setting up a limited company as you will need to register your business with Companies House and register for Corporation Tax which can be done at the same time in most cases.
- An incorporation fee is charged to register your company through Companies House.
- You must appoint company directors which is a minimum of one person. This person/s will be liable for the company meeting its statutory responsibilities such as keeping and maintaining company records, filing annual accounts and making a Company Tax Return. However, they do not need to do all this work themselves, but they have to ensure that it is done. You can also appoint a company secretary that can take on some of these responsibilities, but liability will remain with the directors.
- You must keep Companies House informed of certain changes about your business which includes a change of registered address, change of directors and company secretary.
- You need to submit annual documents before the deadline which includes profit and loss account, balance sheet, auditors report (if applicable), directors’ report and confirmation statement as well as submitting Company Tax Return.
- The above legal and financial requirements might mean that you need to employ an accountant to do your company accounts and make these returns. You may decide to have an accountant do your Self-Assessment tax return as a sole trader, but the cost of limited company accounts will be higher as the requirements are greater.
- If you receive dividends on top of a salary from your business, you will also need to complete a self-assessment tax return as an individual.
- You need to complete P11D forms for all benefits and expenses provided to directors and employees and a CT600 which lists your company’s income minus tax allowances and expenses which need filling with the HMRC.
- You will also need to manage tax and National Insurance for your employees even if you are the sole employee if it exceeds the primary threshold and pay employer’s National Insurance contributions if you exceed the secondary threshold.
- The additional costs as outlined above can often be a barrier for some businesses from becoming a limited company, however, some of these administrative burdens have lessened and it may be worth contacting an accountant to understand what the cost difference is between doing the accounts for a sole trader and a limited company.
- There are restrictions on who can set up a limited company which may prevent you from doing it. You must be over 16 years old and you must not have an undischarged bankruptcy status.
- Your company information will be more publicly available as your information will be displayed on Companies House which includes the directors and company secretary details being displayed as well as copies of financial documents in the filing history, and any changes to your registered address and directors and company secretary.
So, which business structure should you choose?
Whether you choose to be a sole trader or limited company comes down to how your business is going to operate, what you feel comfortable with, your business aspirations, the industry you will be working in and who your customers are going to be as this may determine which structure you decide to use.
When deciding on which type of structure, you should weigh up the pros and cons of each type based on which of these will affect your business and add a weighting to those which are most important to you.
It is worth noting that setting up as a sole trader can be easier to do and you can always switch over to becoming a limited company when you are established or when you feel you need to, although there are steps you would need to make to do this. However, if you set up as a limited company and decide that you want to change to be a sole trader, this is not as easy to do as you would need to dissolve your business. So, it is important to give the decision thorough consideration to prevent issues further down the line.
If you are still not sure which business structure you should have then it may be worth discussing your business with an accountant or an independent business advisor. They can help you explore the requirements that your type of business will have and they can help you weigh up the benefits and drawbacks of each business structure.
If you decide to set up your new business as a limited company, it is worth reading our article on Setting Up and Registering A Limited Company in the UK as it takes you through the steps you need to take, what information is needed and explains some of the terms and roles involved. We also have another interesting guide on How to Start A Business in the UK and Avoid Expensive Mistakes which can help you to understand all the actions and decisions you need to make to get your business set up.