When you decide to set up a new business, there are many things that you need to consider but one of the most important things to think about is the business structure you want to have as this will determine your legal structure. You will need to make this decision before you start running your business and this decision will determine how you will formally set up the business.
Most businesses choose between being a sole trader or a limited company which is why we decided to explore the differences between these two business structures in this article. In 2019 there were 5.8m small businesses in the UK, of these 3.5m were sole traders and 1.9m were limited companies, making over 60% of small businesses sole traders.
You have the option of setting up your business as a sole trader, partnership, or limited company. A sole trader is where you operate on his own with the sole proprietorship of the business. A partnership is when more than one person owns the ownership of the business, but they run it in a similar way to a sole trader.
A limited company is a registered company that has a legal separation from its owners, shareholders and management team, thus this reduces the liability on the individuals involved in the business.
There are two types of limited companies either limited by shares or limited by guarantee. A company restricted by shares is generally one that is managed for profit and has shareholders in the business. A limited guarantee company is usually those not-for-profit companies and will have guarantors, not shareholders, and profits will be reinvested into the business.
It can be difficult to decide whether you want to be a sole trader or a limited company because there are so many pros and cons on each side to think about. That’s why we’ve created this piece on Sole Trader vs. LLC so you can help you decide.
We have compiled a list of all the pros and cons so you can make an informed decision on what is most important to your business.
What are the advantages of being a sole trader?
There are many advantages to being a sole trader or self-employed which include:
- Setting up as a sole trader is easier than doing in a limited company as you will only need to register with HMRC as an independent agent in order to self-assess your tax return, and when you do, you must also be registered with National Insurance.
- You will only need to file a self-assessment tax return each year and there are no other requirements on you regarding government reporting or financial accounting.
- You will have greater privacy for yourself and your business as your details will not be included in Companies House, unlike limited companies.
What are the advantages of being a limited company?
There are many advantages of being a limited company which includes:
- By far the biggest advantage of being a limited company is that you will have a legal separation between you and the company. This means that you will not be financially responsible for the business as your personal funds are separated from the business at the point you incorporated the business. As a sole trader, this is not the case. An LLC can only be charged for what the company itself owes, so in a worst-case scenario, the individual will only lose what they have invested in the business.
- Limited companies can also be more tax efficient than sole traders because they pay corporate tax rather than income tax. Corporation tax can now offer better tax rates, so being a limited company can reduce your taxes. There are also more tax-deductible costs and allowances that can be made if you are a limited company.
- You can also pay dividends to owners or shareholders which is more tax efficient and can give individuals a larger tax-free allowance since everyone gets a dividend tax credit in addition to the personal tax credit.
- Ownership of a company can be easily divided between different people because you can determine this by dividing the shares of the company.
- Your business can grow with you as you start hiring employees.
- As a limited company, it is likely to contract with other companies, especially large corporations and public sector organizations. This is because of the perception of your business as a limited company where you will have checks on your business and your accounts will be publicly available which will make your business more transparent.
- By registering your company name with Companies House, it can prevent anyone from using the exact same company name, and there will be a need to distinguish between any similar names. Sole traders do not have this protection for their company name.
What are the disadvantages of being a sole trader?
As with most things, there are some downsides to being a sole trader which include:
- The biggest disadvantage of being a sole trader is that you will not have a legal separation of business and will be financially responsible for your business. If the business goes into debt or is liable for their business, the owners will have unlimited liability for the business which could result in personal loss of assets owed.
- For this reason, it is important that you obtain adequate business insurance to cover your liabilities and to protect you and your family. We have done many reviews on the various insurance products available in the market which includes the self-employed and sole traders although it is worth noting that you will need insurance regardless of your business structure and all businesses should explore their own insurance requirements.
- Many sole traders can find it difficult to work with large companies or public sector organizations because their sole trader position is against them while a limited company is viewed differently because it is more transparent.
- Many sole traders will often end up changing their business to a limited company to get hold of these types of businesses or they will use an umbrella company as an intermediary to take over the business.
- If you need to raise some financing for your business, it can be difficult for sole traders as investors and banks prefer limited companies which may influence the growth of your business.
- If you work as a sole trader and have a high earnings rate, you may be worse tax-wise since tax rates may not be in your favor.
- You don’t need to register your company or name, but that means there is no protection from someone else using the same company name as you.
What are the disadvantages of being a limited company?
There are also disadvantages of being a limited company which include:
- There are two more steps to setting up a limited company as you will need to register your business with Companies House and register for corporate tax which can be done at the same time in most cases.
- The incorporation fee is charged to register your company through the Companies House.
- You must appoint the directors of the company so that their number is not less than one person. This person/persons will be responsible for the company fulfilling its statutory responsibilities such as keeping and maintaining company records, filing annual accounts and filing the company tax return. However, they don’t have to do all this work themselves, but they do have to make sure it is done. You can also appoint a company secretary who can take on some of these responsibilities, but the responsibility will remain with the managers.
- You must keep Companies House informed of certain changes to your business which include change of registered address, change of directors and company secretary.
- You need to submit annual documents before the deadline which includes profit and loss account, balance sheet, auditors’ report (if applicable), directors’ report and confirmation statement as well as filing the company tax return.
- The above legal and financial requirements may mean that you need to hire an accountant to perform your company’s accounts and generate these returns. You may decide to have an accountant self-assess your tax return as a sole trader, but the cost of limited company accounts will be higher since the requirements are greater.
- If you receive earnings on top of a salary from your business, you will also need to complete a tax return to self-assess as an individual.
- You need to complete P11D forms for all benefits and expenses provided to directors and employees and the CT600 which lists your company’s income minus tax allowances and expenses you need to fill out to HMRC.
- You will also need to manage taxes and National Insurance for your employees even if you are the only employee if you exceed the primary limit and pay your employer’s National Insurance contributions if you exceed the secondary limit.
- Additional costs as outlined above are often a disincentive for some companies to become a limited company, however, some of these administrative burdens have eased and it may be useful to contact an accountant to understand the cost difference between doing the accounts for a sole trader and a limited company.
- There are restrictions on who can set up a limited company which may prevent you from doing so. You must be over 16 years of age and must not have an undrawn bankruptcy case.
- Your company information will be more publicly available as your information will be displayed on Companies House which includes details of the directors and company secretary being displayed as well as copies of financial documents in your registration record and any changes to your registered address, directors and company secretary.
So, which business structure should you choose?
Whether you choose to be a sole trader or a limited company, it comes down to how your business operates, what you feel comfortable with, your business aspirations, the industry you will be operating in and who your customers will be as such. Determine which structure you decide to use.
When deciding on a type of structure, you should weigh the pros and cons of each type based on which ones will affect your business and add weight to those most important to you.
It is worth noting that setting up as a sole trader can be easier and you can always switch to a limited company when it is set up or when you feel you need to, although there are steps you need to take to do this. However, if you set up as a limited company and decide that you want to change to become a sole trader, it will not be easy to do as you may need to dissolve your business. Therefore, it is important to give the decision a thorough consideration to prevent further problems in the future.
If you are still not sure about what business structure you should have, it may be worth discussing your business with an accountant or independent business consultant. They can help you explore the requirements your type of business will have and can help you weigh the pros and cons of each business structure.
If you decide to set up your new business as a limited company, it is worth reading our article on setting up and registering a limited company in the UK as it takes you through the steps you need to take, what information is required and explains some of the terms and roles involved. We also have another interesting guide on how to start a business in the UK and avoid costly mistakes that can help you understand all the procedures and decisions you need to take to set up your business.