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  • Starting a business
    • Business planning

Sole trader vs limited company

  • Article

When starting your own business, you should choose a company structure that supports your growth ambitions and is easy to manage. To help your decision, we explore the difference in being a sole trader vs limited company, the pros and cons of each option, legal requirements, personal liabilities, tax implications, and more.

The difference between a sole trader and a limited company
Advantages of sole trader over limited company
Disadvantages of sole trader
Advantages of limited company over sole trader
Disadvantages of limited company
Choosing between a sole trader and a limited company
Changing from sole trader to limited company
When should I change from a sole trader to limited company?
Can a sole trader be a limited company?
Transferring assets from limited company to sole trader

The difference between a sole trader and a limited company

The main difference between a sole trader and a limited company is the legal structure.

Sole traders are self-employed individuals, who are the sole person in their business. As a sole trader, you have total control over any business assets and profits. This also means you are personally liable for all the debts of the business.

A limited company is a separate legal entity, distinct from you as its owner (or shareholder). This distinction is important as it gives the owner ‘limited liability’, which means your personal assets are protected if the company experiences financial difficulties. This reduces some of the risk of creating a business.

Another key difference relates to tax. Sole traders pay income tax on their business profits, while limited companies pay corporation tax. The admin demands can vary, but a sole trader will be undertaking all of them, unless paying for services, such as an accountant.

Limited companies also need to register with Companies House and file annual accounts and reports, while the paperwork for sole traders is usually more straightforward.

The choice will depend on several factors, including the nature of your business, its income, and your personal preference. You should consider your business needs first, and you may also wish to seek professional advice.

Advantages of sole trader over limited company

To help you decide your company structure, you can weigh up the benefits of sole trader vs limited company.

  1. Being a sole trader is simple:

    One of the biggest advantages of being a sole trader is simplicity. Because there is no distinction between you as a sole trader and your business, there are fewer legal and financial requirements to meet. This makes it easier to get started and run a business on a smaller scale.
  2. Sole traders have complete decision control:

    Sole traders have complete control over their business decisions, and they keep all profits earned. Sole trading is a very popular choice for entrepreneurs and freelancers in the UK.

However, if you have plans for steady growth and expansion, which may require more employees, or need to regularly engage expertise, resources or something else, you should also consider the disadvantages associated with being a sole trader.

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Disadvantages of being a sole trader

There are five potential disadvantages that come with being a sole trader:

  1. Personal liability:

    As a sole trader, you are personally responsible for any debts the business incurs. This means your personal assets, such as your home or car, could be at risk if the business fails.
  2. Prestige:

    Some customers and suppliers may see sole traders as less established, or less stable, compared to larger companies, which could impact your ability to attract business.
  3. Limited tax planning:

    Sole traders may have fewer opportunities for tax planning compared to limited companies. For example, they cannot draw dividends, which usually carry a lower tax charge.
  4. Finance options:

    Being a sole trader can limit funding options. For example, some forms of finance require a business to issue shares, which would require restructuring to a limited company.
  5. Sole responsibility:

    Running a business alone can be stressful and time-consuming. You're responsible for all aspects of the business, from sales and marketing to accounting and administration.

While there can be disadvantages, many of today’s successful businesses started out as sole traders. It's important to weigh any drawbacks against the potential benefits of being a sole trader when deciding on the best structure for your business.

Advantages of limited company over sole trader

There are five potential advantages to starting a business as a limited company:

  1. Limited liability: In a limited company, your personal liability is 'limited' to the amount you have invested in the business. This means your personal assets such as a car or even your house are protected if the business runs into financial difficulties.
  2. Tax efficiency: Limited companies often have more tax-efficient structures than sole traders. For instance, you would pay corporation tax on profits, which is usually lower than the income tax rates that sole traders pay. Also, directors can choose to take a small salary and receive additional income as dividends, which can lead to a lower tax bill.
  3. Raising capital: It's generally easier for a limited company to raise capital by issuing shares, which can be important for growth and expansion.
  4. Continuity: A limited company has a separate legal entity from its owners. Therefore, it can continue to exist even if the original owners leave the business. This means you can create a legacy for the business.
  5. Greater growth potential: Limited companies often find it easier to scale up and grow, as they can bring in more shareholders and secure investment more easily.

While these are potential advantages, they may not apply to all businesses and situations. Always consider your specific circumstances and seek professional advice if needed.

Disadvantages of a limited company

Setting up as a limited company may also have some disadvantages compared with being a sole trader, including:

  1. Complex setup and administration: Incorporating a limited company involves more paperwork than operating as a sole trader or partnership. This includes registering with Companies House, which comes with a fee. Also, the company's accounts must be filed publicly, which can be an administrative burden.
  2. Greater responsibility: Directors of a limited company have legal responsibilities to ensure the company is run lawfully. Failure to meet these obligations can result in penalties or disqualification as a director.
  3. Limited financial privacy: A limited company's accounts are made public through Companies House, meaning financial performance is visible to competitors and the wider public.
  4. Potential for conflict: If there are multiple shareholders, disagreements may arise over the direction of the company or the distribution of profits.
  5. Taxation: Limited companies pay corporation tax on their profits, and directors who draw a salary will also pay income tax and national insurance contributions. There's also the issue of 'double taxation' if profits are distributed as dividends, which are subject to Income Tax after Corporation Tax has been paid.
  6. Running costs: There are costs associated with setting up and running a limited company, including accountancy fees, Companies House fees, and the potential for higher banking charges.
  7. Difficult to close down: If you decide to stop trading, closing down a limited company can be a complex and potentially costly process.

Choosing between a sole trader and a limited company

It can feel daunting to make such a big decision as choosing between a sole trader and a limited company structure.

Understanding the benefits and drawbacks of each option is a great starting point. You can also ask yourself some questions to aid the decision:

  • Do I want to have complete control over my business operations and retain all the profits? A sole trader may be the best option for you.
  • Am I looking for a level of legal protection and to limit personal liability? Then a limited company may be best.
  • Do I plan to rapidly scale and grow the business? A limited company could support growth if you need to access further funding.
  • Do I want to set my own hours and work-life balance? A sole trader could be the right route.

It's important to carefully consider your goals and priorities before deciding which structure will suit your needs.

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Changing from sole trader to limited company

As your business grows, you may wish to consider moving on from being a sole trader to starting a limited company. Your priorities or even your business needs may change over the years.

If you want to change from being a sole trader to running a limited company, there are several steps involved:

  1. Choosing a company name:

    You may already have a company name as a sole trader, but a limited company must have one by law. It must be unique and not already in use by another company.
  2. Registering with Companies House:

    You'll need to provide details about your business and directors and submit specific documents.
  3. Informing HMRC:

    You must let HMRC know about your change in business structure and register for Corporation Tax.
  4. Transferring assets:

    If you have any business assets as a sole trader, you will need to transfer them to your limited company.
  5. Opening a business bank account:

    You will need a separate business bank account to manage the finances of a limited company.
  6. Informing stakeholders:

    You should inform clients, suppliers, and others doing business with you, about your change in legal status.

The move from sole trader to limited company has significant legal and financial implications. It's important to seek professional advice before making the transition.

When should I change from a sole trader to limited company?

If you’re thinking of moving from sole trader to limited company, the decision is usually influenced by the growth of your business and the desire for greater financial protection. Here are some factors to consider:

  1. Financial efficiency: When your annual profits reach a certain point, often suggested to be around £25,000 to £30,000, it may become more tax efficient to operate as a limited company due to the differing tax rates and allowances on offer.
  2. Limited liability: If your business carries significant risks or if there's concern about personal financial exposure, operating as a limited company can offer protection as your personal business assets are treated separately.
  3. Company status: Some clients or industries prefer dealing with limited companies as they are often thought of as projecting a more ‘professional’ image, and providing a greater degree of recourse if any disagreements should arise.
  4. Growth and investment: If you're planning to expand your business, attract investors, or sell shares, then operating as a limited company becomes essential.

The transition to a limited company also brings an increased workload and reporting responsibilities. Discussing this move with a financial advisor or accountant who understands your specific situation is always a good idea.

Can a sole trader be a limited company?

No. A sole trader cannot simultaneously be a limited company. These are two distinct types of business structures with their own legal, financial, and tax implications.

However, as a sole trader you can change your mind and register to run your business as a limited company. The decision to switch should be based on factors such as the size of your business, the need for liability protection, and the wish for greater control over your finances.

You will also need to set up a business banking account if you don’t already have one.

Transferring assets from limited company to sole trader

Whether you’re winding up a company altogether, or if one of the owners is leaving the business, you may want to establish yourself as a sole trader. When moving assets from a limited company to a sole trader, there are a few things you can do for a smooth transition.

  • First, it's important to consider any tax implications that may arise from the transfer. You should seek professional advice from an accountant or tax specialist to ensure you comply with all relevant regulations.
  • Second, you need to choose the right banking solutions to suit your needs. HSBC UK offers a comprehensive range of business banking products and services, which can help simplify the process of transferring assets.

By following the right procedures and taking advantage of professional support, assets can be transferred smoothly, letting you focus on growing your business.

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