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Choosing the legal structure of your business, no matter the size, is an essential part of running a business. The vast majority of businesses will end up either as a Sole Trader or a Limited Company. There are an estimated 3.4 million businesses operating as a sole trader, and 1.9 million limited companies. Clearly, both legal structures are popular. However, what is the difference between the two options, and which might suit your business more?
What is a Sole Trader?
A sole trader is arguably the most simplistic form of business structure, and is essentially a business where a self-employed person is the sole owner of the business. Due to the fact it is the most simple structure out there, it is the most popular and most accessible option. You can set up a sole trader business via the GOV.UK website. As an owner of a Sole Trader business, you and the business are treated as a singular entity. That means if you have business debts as a sole trader, then your personal assets are at risk.
Pros of a Sole Trader
These structures are incredibly simple to set up, and involve a relatively small amount of paperwork. The main admin required with a Sole Trader company is your annual tax return self-assessment.
As you will not be listed on Companies House, the argument can be made that the ownership of a Sole Trader company is somewhat more private when compared to a Limited Company.
No legal requirement to prepare and submit annual accounts, or any corporation tax accounts to HMRC. If you are a sole trader, there is actually no legal obligation to file any accounts that a limited company is obligated to do.
Cons of a Sole Trader
Unlimited Liability. This is the core downside to a Sole Trader, and essentially means that your liabilities are not limited to the assets of the company, and your personal assets have the potential to be exposed.
It can be more complex to obtain finance from a bank, which can limit expansion opportunities. Banks generally favour working with a limited company setup.
Depending on the specific circumstance, a sole trader generally receives less favourable taxation than a limited company, especially once you have surpassed a certain level of earnings.
What is a Limited Company?
A limited company is a business structure where the business has been defined as its own legal entity, separate from the owners (or shareholders) of the business. This means, as the name states, that the liability is limited to the assets that the company owns. In simple terms, a shareholder in the business could not lose their personal property if the limited company was ordered to pay £1,000,000 - for example.
Pros of a Limited Company
A limited company has the benefit of having limited liability. This is formed as the company has been legally defined as separate from the business owner. You can only lose the assets which you put into the company.
There is the potential for a limited company to be more tax efficient than a sole trader, especially as earnings increase. Rather than paying income tax, a limited company will pay Corporation Tax on earnings, which is currently 19%. This can mean that a limited company, all revenue being equal, would be more profitable than a comparable Sole Trader.
Further to the more favourable tax rate, a limited company also has more access to allowances and tax-deductible costs to claim against profits.
There is protection against the name of the company. Once a company name is registered, then nobody else can take that name. However, a Sole Trader does not have that same protection.
There is a perception that a limited company may be more ‘professional’ to work with than a Sole Trader, especially if your business is a professional service (lawyers/accountants/consultants etc). A limited company can be perceived to be more credible to any parties who may consider working with you in this example.
Cons of a Limited Company
There are significantly more responsibilities and admin associated with running/owning a limited company, compared to a Sole Trader. These are called the Director's Fiduciary Responsibilities. For example, you will have a requirement to file a confirmation statement, as well as annual accounts.
Due to the aforementioned increased level of responsibilities means that a limit company can have increased costs to continue running (as well as increased time requirements). Whether you handle the extra paperwork and admin yourself, or hire someone else to do it for you, there will be a significant increase in requirements.
There is a lack of privacy. Someone can easily find your registered business address, as well as the company directors and even the filed annual accounts on Companies House. The increased level of transparency here may push some away.
You will generally need more external help when running a limited company. Whether that be engaging with a lawyer to recommend certain structural changes within the business, or an Accountant to prepare the annual corporation tax accounts for HMRC. Comparatively, you can generally get by being a one-man-band when running a Sole Trader business.
Summary
Ultimately, there are significant pros and cons to both options, and it is important to weigh out your personal circumstances in order to conclude which structure would benefit you the most. Do not rush into a decision, and always speak to an Accountant if unsure about your decision, especially regarding the tax implications of either option.
At the core of your decision should be an analysis of where the business is likely to go, and what you envision it being. As the main differentiator between a Sole Trader and a Limited Company is the ‘limited liability’, this is something to strongly consider. If your business has the potential to come under any legal action, then it makes logical sense to go down the route of a Limited Company, as otherwise any legal action against your Sole Trader business is effectively legal action against you individually as in the eyes of the law, you and the business are the same entity. It is therefore essential if going down the route of a Sole Trader to look into small business insurance, to stop the implications of being sued.
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