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.
We’re here to help. In this comprehensive guide, we’ll look at the pros and cons of each approach, as well as how to get set up using either option. Without further ado, let’s get started.
What is a sole trader?
A sole trader is someone who is self-employed and runs their own business as an individual. The business 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 keeping records of business sales, spending and financial affairs. This includes sending a Self Assessment tax return every year and registering for VAT if and when 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 distinct from the individuals who own and operate 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. This means that the company is divided into equal shares with a monetary value attached to them, and these shares are 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 biggest difference is the issue of 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 any and all losses that your business might make.
- The paperwork involved as a sole trader tends to be a bit more straightforward than that of a limited company. But, this is offset by limited companies generally being more tax efficient.
- Sole traders are, for the most part, self-employed individuals whereas limited companies can range from a business of one person to many hundreds.
The pros and cons of being a sole trader
Let’s take a look at some of the most common positives and negatives of becoming a sole trader:
Pros
- There is a fairly small amount of paperwork involved when setting up as a sole trader.
- You don’t have to publish details of your business 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 of the 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 all at risk.
- Operating as a sole trader you’ll more than likely end up paying more tax than an equivalent limited company.
- In certain sectors, potential clients much prefer to deal with limited companies rather than sole traders.
- If you are looking to grow your business, the sole trader structure can become quite restrictive fairly quickly.
- If you’re seeking investment from banks or other financial institutions, you might be looked upon less favourably 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 main 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.
- In most circumstances, you’re likely to pay less tax as a limited company than you would as a sole trader.
- There are more things that you can claim as a business expense than you would be able to as a sole trader
- A limited company is generally seen as 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
- Without support from a specialist, there is generally more paperwork when setting up than going down the sole trader route.
- As a shareholder, your personal details will be available for the public to see via Companies House.
- Any key business decisions will have to be agreed by all shareholders.
- You’ll need to be aware of the pitfalls of IR35.
- It’s highly advisable to employ the skills of an accountant in order 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 that you have any industry-specific licences in place). Unlike a limited company, you don’t need to register with Companies House.
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.
The only other thing you’ll need to do is appoint an accountant, who’ll be able to advise you on the most tax-efficient way of working through your 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 sole traders and limited companies. But which is the right choice for you? Well, the short answer is: it depends. If you’re comfortable to stay as a small business and you are not concerned about having to pay slightly more tax on your profits, then there’s no reason why working as a sole trader wouldn’t be suitable.
But if you think that you’ll want to grow your business in the future, and you’re keen to be as profitable as possible, then operating as a limited company might well be your best option. You’ll be seen as more credible by clients and investors, and your personal assets won’t be at risk.
In summary
There’s no doubt about it: making the decision to go limited or sole trader is a big one. But we hope this guide has helped to inform you about making the best choice for you and your next business venture.
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