Sole trader vs limited company: Which one is right for you?

You’ve got a great idea for a business, you’re ready to branch out on your own, but how should you structure your new enterprise? Last year there were 5.7 million businesses in the UK, according to official figures, and the most popular choice among them was to operate as a sole trader. Sole traders accounted for 59% of the total, while 34% were limited companies and 7% ordinary partnerships. But what are the pros and cons of these two most common company structures, and how can you decide which one is right for you?

Sole trader

Many one-man band businesses start life as sole traders. Under this structure, you are considered self-employed and you and your business are treated as a single legal entity. Crucially, this means if your company ever gets into trouble, you are personally liable for its debts, and your assets could be taken to repay creditors. A big advantage, however, is that your business’s profits are yours to do with what you like - you can take all the profits your business makes as income, although it will be subject to income tax and National Insurance Contributions.

Sole traders have an easier time when it comes to paperwork – they don’t have to provide the same information on shareholders and directors to Companies House that a limited company would. However, they still need to keep careful records of their business activities, including sales and expenses. As a sole trader, you will also need to file a self-assessment tax return each year, and if your turnover is above the VAT threshold, you will also need to register for VAT and file a VAT return or face fines.

It’s easy to set up as a sole trader, you just need to tell HMRC you are self-employed, register for self-assessment, and decide what to call your business. You can trade under your own name or a business name, but there’s nothing to stop someone else stealing it unless you get it trademarked, unlike if you were a limited company.

Many company founders start out as sole traders and then incorporate to become a limited company later once their business is established and they can see the benefits it might bring.

Limited company

So, what are the benefits of setting up a limited company? A key selling point is that this structure separates you from your business by making it a legal entity in its own right. Your personal assets remain ringfenced in the event the business fails owing money to creditors.

Setting up a limited company is a little more involved than if you were a sole trader. You can register your company with Companies House yourself or get an accountant to do it for you, and you’ll have to pay a registration fee. You’ll need to choose a company name that’s not too similar to one that already exists, and let HMRC know if you will be employing any staff and need to register for PAYE. Once your company is set up, you become a director and shareholder, and you must tell Companies House who owns shares in your business and their value, even if you are the only shareholder.

Limited companies will usually have to pay corporation tax on their profits, and directors will pay income tax on any drawings such as dividends and salary above the personal allowance and the dividend allowance. But this can be a more tax efficient model than if you were a sole trader, as long as you are getting the right advice (click here to find a good accountant).

Another major advantage of incorporating as a limited company is that it makes you appear more professional and reliable. In fact, some big businesses will only deal with limited companies, so you could lose out on contracts by being a sole trader. And, if you’re looking for investment in your business in future, you will probably find it easier to raise this as a limited company than as a sole trader whose personal financial affairs are entangled with their business.

On the downside, as a company director, the buck stops with you. You are responsible for making timely regulatory filings to HMRC and Companies House such as your annual accounts and tax return, and you could be hit with fines if you fail to meet your obligations here. You will also need to tell Companies House if certain changes happen within your business, such as directors coming on board or exiting.

So, although there is more admin to take care of and your business might be less nimble than if you were a sole trader, running a limited company can also be more tax efficient and give you greater stability.

If you are unsure of the right structure for your company, you might want expert guidance. PROfiltr can help you find a small business accountant who can advise you on the most appropriate choice for your business.