When you’re starting a business, one of the first decisions you have to make is whether to operate as a sole trader or limited company.
Both have their pros and cons, so it can be difficult to decide which is right for you. What are the differences between the two types? Which one has advantages that work better for your business?
In this blog post, we will discuss the differences between Sole Traders and Limited Companies, and help you decide which is the best option for your business.
What is a Sole Trader?
Sole Traders are the simplest type of business structure when considering sole trader or limited company structures.
It is easy to set up because you don’t have to go through the process of incorporating a company. All you need to do is register with HMRC and set up a business bank account, meaning it is a very quick process and can be done with very little cost.
As a Sole Trader, you are self-employed and run your own business. You are the sole owner and decision-maker, and you can keep all of the profits after tax. This makes Sole Traders very flexible, as you can make decisions quickly and without consulting anyone else.
However, this also means that you are solely responsible for any debts or losses incurred by the business.
Unlimited liability is one of the biggest disadvantages of being a Sole Trader because it can put your personal assets at risk.
What is a Limited Company?
Limited Companies are slightly more complex, but offer some advantages over Sole Traders.
Limited Companies are owned by shareholders, who appoint directors to manage the company on their behalf. This gives Limited Companies a level of protection from personal liability, as the shareholders are not responsible for the debts of the company.
However, this also means that decision-making can be slower, as directors have to consult with shareholders before making major decisions. The business also takes longer to set up because you have to go through the process of incorporation.
Limited Companies also have to pay Corporation Tax, which is a tax on company profits. This is separate from the income tax that shareholders have to pay on their dividends.
There are also two types of limited companies to consider.
Public limited companies are owned by the shareholders and can sell shares to the public via the stock market. These companies have to have a turnover of more than £25,000 and their shares must be worth more than £50,000.
Private limited companies are owned by a smaller number of shareholders and cannot sell shares to the public. These are often smaller companies and have less stringent financial requirements.
Advantages of being a Sole Trader
One of the biggest advantages is that you have complete control over your business.
Decision Maker
As the sole owner, you can make all of the decisions about what direction to take the business in. This means that you can be very flexible and responsive to changes in the market. It also means that you don’t have to consult with anyone else before making decisions, which can speed up the decision-making process.
Profitable
Another advantage of being a Sole Trader is that you get to keep all of the profits after tax. This isn’t the case for Limited Companies, where shareholders only receive dividends after Corporation Tax has been paid. This can make Sole Traders more profitable in the long run because you don’t have to share out the profits with any shareholders.
Privacy
There is more financial privacy as a sole trader. This is because your financial affairs are not public information like they are for Limited Companies because they don’t have to give as much information to Companies House.
This can be an advantage if you want to keep your business affairs private or just not available to your competitors to compare themselves against. This may give you a competitive advantage over a Limited Company.
Less Obligation
Sole Traders also have less paperwork and compliance obligations than Limited Companies.
This is because they are not required to file annual accounts or hold shareholder meetings. This usually makes Sole Trader businesses simpler and easier to run than Limited Companies as less time is spent filling out paperwork instead of running the business.
The reduced legal requirements in paperwork also mean that Sole Traders can save money on accountancy fees.
Advantages of being a Limited Company
Liability
One of the biggest advantages is that you have limited liability. This means that if your business gets into debt, the shareholders are not personally responsible. This can protect your personal assets from being seized to pay off debts.
Raising Finances
Another advantage of being a Limited Company is that it can be easier to raise finance. This is because investors are more likely to put money into a company that has limited liability. Shareholders can buy shares to raise money for the company, meaning that you don’t have to take out loans with personal guarantees.
Reputation
Finally, Limited Companies often have a better reputation than Sole Traders. This can make it easier to win customers and suppliers. People often think that Limited Companies are more professional and better run than Sole Trader businesses because of the increased paperwork and compliance requirements and legal structure.
Disadvantages of Being a Sole Trader
It’s always important to take into account the risks.
Unlimited Liability
One of the biggest disadvantages is that you have unlimited liability.
This means that if your business gets into debt, you could be personally responsible for the debts. This could put your personal assets at risk, such as your house or car. This is because your business is not seen as a separate legal entity and so your personal assets can be used to pay off business debts.
Reluctant Investors
Another disadvantage of being a Sole Trader is that you might find it harder to raise finance. This is because investors are often more reluctant to invest in a Sole Trader as there is no limited liability.
They may also be put off by the lack of paperwork and compliance requirements as this can make the business appear less professional. This means that the business may not be able to grow at the same rate as a limited company because it can’t raise as much money.
Tax
These businesses are less tax efficient. This is because any profits that the business makes are taxed at your personal tax rate. This can be higher than the corporation tax rate for limited companies, at 20-45% rather than just 19% for limited companies. As a result, you may have to pay more tax as a Sole Trader than if you set up a Limited Company.
Disadvantages of Being a Limited Company
There are some disadvantages of being a Limited Company as well.
Corporation Tax
One of the biggest disadvantages is that you have to pay Corporation Tax. This is a tax on company profits, which can eat into your profit margin.
Middle Man
Another disadvantage of being a Limited Company is that decision-making can be slower. This is because directors have to consult with shareholders before making decisions. This can make it harder to be flexible and responsive to changes in the market.
Set-Up
Finally, Limited Companies often have more compliance requirements than Sole Traders. This can mean more paperwork and cost more money to set up and run.
So, is a Sole Trader or Limited Company better for You?
It depends on your personal circumstances and what you want from your business. Once you’ve looked through the pros and cons and weighed up what is important for your business, you can then decide which structure works best for you.
If you’re just starting out, then being a Sole Trader might be the best option as it’s simpler and easier to set up. You’ll also have complete control over your business.
However, if you’re looking to grow your business or raise finance, then a Limited Company might be the better option. This is because investors often see Limited Companies as being more professional and better run. Ultimately, it’s up to you to decide which business structure is right for you and your business.
If you’re still not sure, it’s always best to speak to a professional accountant or business adviser who can help you decide which structure is right for your business. Get in contact with us if you would like some advice or help with the legal requirements involved in setting up or maintaining a sole trader or limited company.
