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When it comes to legal business structures, entrepreneurs have an option to register as a sole trader (or partnership) or as a limited company. If you are new to the business, choosing between the two can be quite a dilemma. It is important to consider all factors before making a decision on which legal structure works best for your business.
That is why we’ve outlined the definition, advantages and disadvantages, and the difference between a sole trader and a limited company. Let’s take a look at it together.
What is a Sole trader?
Essentially, a sole trader is a self-employed person who is the sole owner of his/her business. Legally, you and your business are recognized as a single entity. It is the simplest business structure out there, in terms of paperwork and setting up. That’s possibly why it is the most popular option for small business owners, with around 60% of registered small businesses in the UK being sole tradership. Registration is also easy. All you need is to register via the gov.uk website for tax purposes.
What is a Limited company?
A limited company, also known as incorporation, is a business structure that sets your business as a separate entity from its owners (shareholder/s) and managers (director/s). The same is true even if the shareholder and director is just one person running the show. Basically, it means setting up your business as a different entity you work for, despite running that business.
Sole trader vs Limited company
Whereas a sole trader is registered under the business owner’s name, with a limited company, you can get creative with the business name. They differ in terms of responsibilities or paperwork expected of them. Taxation is also different, although the dividend changes in 2016 have narrowed the gap between sole traders and limited companies in terms of tax advantage. Both the sole trader and limited company have their own benefits and drawbacks for the business owner. Let’s scrutinize the different pros and cons of the two.
Advantages of a sole trader
Being a sole trader is relatively simple when it comes to the paperwork involved. The most hassle you could get is the annual self-assessment tax return required by the HMRC, which you can do online.
It also offers greater privacy, as the Companies House does not require details of your business.
Moreover, as a sole trader, you have complete control over your business and its finances. All of your business’s profits are considered your income, and you are taxed accordingly. The freedom to employ others or not is also completely up to you, as long as you comply with the various employment laws and ensure that your workers’ rights are upheld.
Disadvantages of a sole trader
A sole trader’s biggest drawback, undeniably, is unlimited liability. The business owner and the business are recognized as the same entity by UK law. Moreover, since you are in complete control of your business, you are also completely responsible. If your business earns debts, your personal finances and assets are at risk of being affected in order to settle your business’s liabilities.
You are also responsible for ensuring that you have various small business insurance policies in place. This is to protect you from getting sued personally, in case your business gets sued.
Additionally, banks and investors tend to prefer limited companies, so raising funds can be quite tricky, limiting expansion opportunities for a sole trader.
Lastly, while tax paperwork is relatively simpler for sole traders, the tax itself can be a bit unkind. This is especially true when you rake in higher profits.
Advantages of a limited company
The main selling point of a limited company is limited liability. Establishing your small business as incorporation can protect your personal finances and assets.
Technically, even if you own the company, you are considered an employee under that company. As such, the profits belong to your business, and what you take home instead, is a salary. This can prove to be more tax-efficient, as you only pay corporation tax and dividend tax. Eventually, this tax efficiency could be the difference it takes to earn more profit. Additionally, there is a wider range of allowances and tax-deductible costs a limited company can claim.
Moreover, limited companies are perceived to be more professional, which can build a good reputation for your business. It adds credibility to your company, which works to your advantage in terms of inviting parties that are interested in working with your business.
Lastly, limited companies are offered the privilege of registering a company name. Once the name is taken, it can no longer be used by other businesses.
Disadvantages of a limited company
The greatest disadvantage of a limited company is the amount of paperwork they are required to submit annually. This involves the annual accounts to be filed with the Companies House, as well as a full corporation tax account for HMRC. There is also the Director’s Fiduciary Responsibilities, which outline the legal responsibilities of a limited company director.
This paperwork is full of technicalities, which can be quite overwhelming. It is recommended to seek out assistance from lawyers and accountants to ensure that this paperwork is thorough and in compliance accordingly. This makes these responsibilities quite costly and time-consuming.
Additionally, information about limited companies can be found in the Companies House records. Details on directors and your companies earnings are required to be shown publicly–transparency that does not appeal to some business owners.
Ultimately, deciding which legal structure is best for your company depends on the different factors at play. You need to consider the nature of your business, finances, workforce, and knowledge. Don’t be afraid to seek counsel from experts regarding your concerns on this. Some people opt to start as a sole trader and once they have learned the ropes of business management, decide to register their business as a limited company. The important thing is to weigh the pros and cons of each structure against what you and your business need right now in order to succeed.
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