At the start of 2019, there were 5.8 million small businesses in the UK. 3.5 million of those were set up as a sole trader while only 2 million were limited companies.
The fact that there are nearly twice as many sole traders doesn’t mean it’s a better choice. Let’s look at the differences between sole traders and limited companies and why you would choose one or the other.
What is a Sole Trader?
A sole trader is someone who is self-employed and is the sole owner of the business. They may operate using a business name but everything they earn is treated as part of their personal income and they’re personally agreeing to any contracts or other arrangements they sign.
What is a Limited Company?
A limited company is a separate legal entity in the eyes of the government and courts. It’s completely independent of the owners (shareholders) and managers (directors).
A limited company may be run by a single person with no employees but it’s still considered a separate entity.
Setting up as a Sole Trader vs Limited Company
Part of the reason more small businesses are operating as sole traders is the relative ease with which it can be set up. To set up as a sole trader, you need to have a National Insurance number and then register for a self-assessment tax return with HM Revenue and Customs (HMRC).
You can do business under your name or using a business name, whatever you prefer. It’s simply a matter of deciding on a name and moving forward from there.
There are several steps involved in setting up a limited company. You need to be at least 16 years of age, have no history of bankruptcy, and have no legal prohibitions from serving as a company director.
Assuming you meet those requirements, you can proceed with registering your company.
Private vs Public Limited Companies
You can register a limited company as either private (LTD) or public (PLC). Public limited companies must have a minimum share capital of £50,000 and at least two shareholders, two directors, and a company secretary.
Because a public company has to meet this higher barrier of entry, most limited companies are set up as LTD. A limited company’s business name has to be unique so you need to find a name that isn’t already used.
Once you find a suitable name, register it with Companies House to protect it against other companies using it.
Pros and Cons of Sole Traders
Being a sole trader has only a few advantages compared to registering a limited company. We’ve already discussed the first one, the ease with which you can set it up.
All you need to do is decide on the name you’re going to use and register to file your Self Assessment return and you’re in business. The second advantage is the low cost of setting up as a sole trader.
Because you don’t have to file a lot of legal documents or create any corporate accounts, there’s very little cost to get set up.
The other potential advantage of being a sole trader is that you have a bit more privacy than a limited company. We’ll get into more detail on this when we look at limited companies.
Disadvantages of Being a Sole Trader
There are a few more disadvantages of operating as a sole trader, one of which is pretty significant. Sole traders have unlimited personal liability for everything that happens in the business.
If the business gets into financial trouble and goes under, a sole trader will be responsible for covering any debt from the business. This can put your home and other investments at risk if there’s ever a problem.
Getting financing can be more difficult as a sole trader as well. Many banks and other lenders are hesitant to lend money to sole traders so you may not be able to raise the funds needed to expand.
The other financial disadvantage of sole traders is from an income tax perspective. A sole trader’s business income gets taxed as personal income so you pay a higher rate than limited companies, which pay corporation tax instead.
How Limited Companies Compare
Many of the advantages of a limited company are on the opposite side of the coin from sole traders, the biggest being a limited liability for the owners and managers.
Because limited companies are separate legal entities, debt and other legal liabilities are limited to the assets within the company itself. Your personal assets aren’t exposed.
Limited companies pay corporation tax which may be taxed at a lower rate than your personal income tax band.
Choosing to operate as a Limited company can also open the door to the numerous benefits of tax planning. You may be able to make considerable savings through tax planning. For example, by having the right balance between your salary and dividends or how much to pay into pension.
Because a limited company’s name is protected by law, the business is also more insulated from someone else using the name and potentially reflecting poorly on your business.
Disadvantages of Limited Companies
If you’re concerned about privacy, limited companies are at a disadvantage to sole traders. When you register a limited company, a lot of the company’s information is publicly accessible through Companies House. If someone wants to find out more about the business, it’s easily accessible online.
The only other disadvantage of a limited company is the cost of maintaining it, in both money and time. There’s more work for the directors in the form of Director’s Fiduciary Duties and the company must file reports and accounts on an annual basis.
These annual reports add to the cost of running the business and the initial registration process also has a cost.
How to Decide on the Right Business Structure
After weighing the pros and cons, it might sound like a limited company is the best choice. That’s often the case but some businesses are better off to set up as a sole trader in spite of its disadvantages.
Given the potential legal ramifications, it’s a good idea to get expert advice before deciding on which route to take. As trusted accountants in London working with companies in many different industries we can help you decide on the right structure for your business.
Request a quote online today to get started.