Sole Trader vs. Limited Company

One of the biggest decisions when setting up as a business is whether to go down the sole trader or limited company route. Fortunately, we've put together a guide to give you all the details for an informed decision.

The road to starting your own business is full of difficult decisions. But one of the most important choices is deciding whether to set up as a sole trader or as a limited company. Picking the wrong route could have long-term implications for your business, and it could even stifle future opportunities when it comes to getting new clients.

Below we'll look at the pros and cons of each, as well as how to get set up. So, let's get started.

What is a Sole Trader?

A sole trader is self-employed and runs their own business as an individual. The company and the person are not separate entities—so, as a sole trader, you're personally responsible for any losses the business makes. Likewise, you keep all of the profits after you've paid tax on them.

Sole traders are personally responsible for recording all financial affairs of their business. This includes sending a Self Assessment tax return every year and registering for VATifn your takings are over the VAT threshold.

What is a Limited Company?

A limited company is a business that is an entity in its own right. That means it is separate from the individuals who own the company, and their liability is limited to the investment they made. (hence the name 'limited').

Limited companies tend to work on a 'shares' basis. Shares mean that the company is divided into smaller portions with a monetary value attached. These shares are then distributed among the shareholders.

All limited companies in the UK need to be registered with Companies House, and they must follow the rules laid out by the Companies Act of 2006.

What is the Difference Between a Sole Trader and a Limited Company?

Let's take a look at some of the key differences between operating as a sole trader and a limited company:

• The most significant difference is with liability. As we mentioned above, as a limited company, you are only ever liable for the amount you invested in the business. But, as a sole trader, you are personally responsible for all losses that your business might make.

• The paperwork involved as a sole trader tends to be a bit more straightforward than a limited company. But, this is offset by limited companies generally being more tax efficient.

• Sole traders are self-employed, whereas limited companies can range from one person to many hundreds.

The Pros and Cons of Being a Sole Trader

Let's take a look at some of the positives and negatives of becoming a sole trader:

Pros

• There is a small amount of paperwork involved when setting up as a sole trader.

• You don't have to publish your business details on Companies House, so your privacy is protected.

• You have complete control over your business. There are no other shareholders to consult and no directors to answer to.

• You get to keep all profits after tax.

• You can sidestep the issues of IR35 and disguised employment (those rules only apply to limited companies).

Cons

• As a sole trader, you are personally liable for any business losses, meaning that your personal belongings and property are at risk.

• Operating as a sole trader, you'll likely end up paying more tax than a limited company.

• Potential clients prefer to deal with limited companies rather than sole traders in certain sectors.

• If you are looking to grow your business, the sole trader structure can quickly become quite restrictive.

• When seeking investment, you may be less favourable if you're operating as a sole trader.

The Pros and Cons of Working Through a Limited Company

Next up, we'll go through some of the pros and cons of setting up a limited company:

Pros

• With a limited company, you will always have limited liability. That means you are only ever liable for the investment you made in the business.

• You're likely to pay less tax as a limited company than you would as a sole trader.

• You can claim more things as a business expense when operating as a limited company.

• A limited company is seen to be more professional than a sole trader. As such, you'll have more credibility when seeking out potential clients.

• You'll have more borrowing power as a limited company. Investors will see you as more reputable than a sole trader, and your limited company will have its own credit rating.

Cons

• There is generally more paperwork when setting up as a limited company.

• As a shareholder, your personal details will be available via Companies House for the public to see

• Any critical business decisions will have to be agreed upon by all shareholders.

• You'll need to be aware of the pitfalls of IR35.

• It's advisable to use the skills of an accountant to get maximum profitability from a limited company.

How do I Become a Sole Trader?

Setting up as a sole trader is a pretty simple process. Firstly, you'll need to let HMRC know that you're now self-employed. Then, you'll need to register for Self Assessment as a sole trader. Remember, you'll need to have a business name ready when you register.

After that, you're pretty much good to go (provided you have any industry-specific licences in place).

If you are a sole trader, take a look at our sole trader accountancy packages.

How do I Become a Limited Company?

There's no denying that there's more paperwork involved when setting up a limited company versus getting started as a sole trader. Fortunately, there are specialists who can help you through the process in a simple, quick, and cost-effective way.

Here at SJD, we can form your limited company online in just five minutes. That includes setting up your company bank account and registering your company for VAT and PAYE.

You'll also need to appoint an accountant, who'll be able to advise you on the most tax-efficient way of working through a limited company. We can help there, too. Check out our guide on finding out what an accountant can do for you.

Sole Trader or Limited Company?

So, we've looked at the definitions and the differences between a sole trader and a limited company. But which is the right choice for you? Well, the short answer is: it depends.

If you're comfortable staying as a small business and are satisfied with paying more tax. There's no reason why working as a sole trader wouldn't be suitable.

But if you think you'll want to grow your business, operating as a limited company might be the best option. Clients and investors will see you as more credible, and your personal assets won't be at risk as a limited company.

Conclusion

There's no doubt that deciding whether to set up a limited company or as a sole trader is a big decision. But we hope this guide has helped inform you about making the best choice for you and your business.