When starting a new business, you need to select the right legal structure for it as this decision can have a notable impact on how it is administered and maintained and what tax rates and paperwork you need to comply with and file. Two options are acting as a sole trader or trading as a limited company.
How are they different?
Sole traders are defined by their joint personal and business obligations. This means that the sole trader, the self-employed business owner, and the actual business are treated as one single entity. A limited company separates the two, with the business acting as a legal entity on its own while the owner, directors and shareholders are separate.
A sole trader takes on more personal risk as assets can be pursued by creditors if the business falls into debt or bankruptcy. A limited company differs again here as an owner is only liable for the money they have put into the business. Also, the administration is different.
One of the benefits of being a sole trader is the reduced burden of paperwork as there are fewer formalities when compared to a limited company, which has to file accounts regularly and follow stringent admin requirements. There are advantages and disadvantages to both options though.
Advantages of a sole trader
Becoming a sole trader is quicker and easier to set up as you don’t have to register with Companies House and paperwork is mainly limited to a single, annual self-assessment text return. HMRC is even simplifying this process with its Making Tax Digital (MTD) initiative. You can also use recognised accounting software that is compliant with MTD to make text returns simpler and more efficient. In addition to less admin, sole traders have more control over their businesses and can retain more profits due to the absence of shareholders. Also, your information is more private as it’s not accessible via Companies House.
Disadvantages of a sole trader
The main downside of being a sole trader is unlimited liability, which means that you are responsible for all of the company’s debts. Also, your business name won’t be protected as it hasn’t been registered, and other companies might see you as a less viable client or customer due to the lack of overall legal protection. In addition, raising funds for your business is more difficult, which can impede long-term growth.
Advantages of a limited company
Around a third of the six million business in the UK are limited companies, according to government data. Becoming a limited company will free you from the personal liability of losses as the business is legally separate, while you will quickly gain more credibility and funding opportunities, both from investors and banks. Limited companies are also more tax-efficient, despite the extra burden, as the 19% rate for corporation tax is lower than the 20%-45% income rate for sole traders.
Disadvantages of a limited company
A limited company is more complex as it requires much more admin. You will need to register with Companies House and file accounts and text returns, which usually require expert assistance from an accountant. There is also less privacy.
When deciding what to do, consider your own personal circumstances and what’s best for your business.