No matter what kind of business you’re running, you need a legal structure in the form of being either a sole trader or a limited company.
There are important distinctions between the two, meaning this is a vital decision for your business. You need to be certain that you’re making the right call for your employment needs.
About 60% of the business population is formed of sole traders, with 33% being made up of limited companies. However, running a business as a sole trader isn’t for everyone. Here’s a look at the key differences between the two, so you can evaluate what works best for you.
What is a sole trader?
A sole trader is a self-employed person who is the sole owner of their business. Anyone who conducts some form of business – from an Etsy seller to a freelance journalist – can be a sole trader. It’s one of the simplest business structures out there, and many people at least start out as a sole trader.
What is a limited company?
A limited company is a type of business that has its own legal identity, which is removed from its owners. It can still be run by just one person, but that person acts as a shareholder as well as director of the business.
The advantages of being a sole trader
It’s simple to do: Being a sole trader is incredibly simple to set up. It takes minutes to become one in the eyes of the law, and there’s hardly any paperwork. For the most part, it all comes down to completing an annual Self Assessment tax return.
You have privacy: As a sole trader, you have far more privacy than as part of a limited company. That’s because you don’t have to list your business on Companies House. It’s entirely private, if you so wish.
No additional costs: Setting up as a sole trader doesn’t cost a thing. You don’t have to spend money arranging annual returns, there’s no Corporation Tax, and you don’t need to pay any additional fees simply to exist. As long as you complete a Self Assessment tax return each year, you’re legally covered.
The disadvantages of being a sole trader
Unlimited liability: Liability is a huge issue for the sole trader. As the sole proprietor, you have unlimited liability. If your business gets into debt, you’re personally liable to repay that.
Potentially, if your business goes under, you could lose personal assets such as your car or even your home.
Difficult to raise funds: It can be tricky to raise capital or funding from key sources. Typically, banks and other investors prefer to provide funds to limited companies. This can lead to restricting your chances of expansion.
High tax: Once your sole trader business is particularly profitable (such as turning a profit over £30,000 per year), tax rates can be harsher on you than if you were running as a limited company. That’s often when it’s worth considering making the switch.
The advantages of forming a limited company
Limited liability: One of the biggest advantages to being a limited company is that your liability is limited. There’s a legal distinction between you and your business. If your business fails, you only stand to lose the company assets, not your own possessions.
Tax incentives: Typically, limited companies are more tax efficient than sole trading. You pay Corporation Tax on your profits rather than income tax, and often this can be more profitable. There are frequently a wider range of allowances and tax-deductibles involved here too.
Your name is safe: Once your company name has been registered, no one else can use it. This is particularly useful within a distinctive industry, or if you have an iconic name for your company.
Bigger presence: Simply by being a limited company, many people and institutions will regard you as a bigger deal than if you stay a sole trader. Added prestige is always a useful bonus when building up your presence within an industry.
The disadvantages of forming a limited company
More accountability: Paperwork isn’t just a matter of an annual Self assessment once you form a limited company. You also need to file a yearly annual return, annual accounts, and conform to what’s known as the Director’s Fiduciary Responsibilities, which outlines what a limited company director must do legally.
It’s time consuming: Because of the extra paperwork, it can be more expensive and time consuming. You also need to pay a fee to incorporate your business. Plus, it’s very wise to hire an accountant rather than do this yourself.
Transparency: Potentially a disadvantage, your business particulars can be found on Companies House, with details on the directors and your company earnings. This isn’t always a welcome idea, depending on your business.
Whatever choice you make, it’s important to receive advice from a professional about your business finances. A good accountant is worth its weight in gold. Don’t hesitate to contact Mazuma today to find out more about their services.
Originally featured on the Mazuma website.