Sole Trader vs. Limited Company: Which Is Best?

A successful company requires a solid foundation. When establishing a new company, the first step you’ll need to take is creating a structure. Company structure will influence a wide range of factors in your fledgling company, from expenses to avenues of growth. When choosing a structure for your company, you have a fair few options available, though the decision often boils down to the two most common options – sole trader vs limited company.

When choosing between starting as a sole trader vs limited company, there’s a lot to consider. In this article, we will cover the two company structures, their pros and cons, and help you settle on the structure that’s best for you.

What is a sole trader?

A sole trader is a structure where the business and its owner are one and the same. You own the business while it simultaneously employs you. As there is little distinction between the business and its owner, operating as a sole trader also merges personal and business finances. Anything that affects your company’s finances, for better or worse, will affect your personal finances as a sole trader.

What is a limited company?

A limited company is a clearly defined business structure that draws a line between a company and its owners. This delineation provides legal protections for limited company owners, limiting liability should anything go awry. If the company’s finances decline, company owners and shareholders will not be expected to step in with their personal finances. Similarly, the company is recognised as its own legal entity, allowing it to own various assets and properties directly. Should any legal action be taken against the company itself, company owners will not be held liable.

How does the registration process work?

The registration process for both business structures is quite different, marking the first major point of consideration when deciding between the two. In addition to a different startup process, both structures have different implications for future opportunities. As such, you’ll need to consider the short-term goals of your business for the most suitable structure.

Registering as a sole trader

Registering your business as a sole trader is quite straightforward and inexpensive. Registering as a sole trader is as simple as registering for Self Assessment for tax purposes. Doing so notifies HMRC of your self-employed status, and will require you to file a Self Assessment tax return each tax year. You will not need to register your business with Companies House.

Alongside an annual tax return, you will also need to register for Class 2 National Insurance, keep records of your business transactions, and register for VAT if your annual turnover exceeds £85,000. Registering for VAT can be done online using the Government Gateway. Lastly, you will need to register under HMRC’s Construction Industry Scheme if you intend to work in the construction industry.

Registering as a limited company

Registering your business as a limited company is a bit more of an investment than registering as a sole trader. It will require you to register directly with Companies House and the payment of a registration fee.

Registering as a limited company is a longer process than registering as a sole trader. You’ll need your company’s name, directors, a company secretary, and its shareholders. You’ll also need a business bank account and documents stating how the company will be run. Lastly, you’ll need to keep a set of records, including details about the company and its operations, and all financial transactions. These records must be kept in case of a compliance check, which HMRC can conduct to ensure your company is paying the appropriate tax.

Can I change from one structure to another?

Deciding how to register your company can be difficult. While registering as a sole trader might be appealing at first, you may want to change to a limited company as your business grows. Thankfully, you aren’t locked into either business structure once you’ve made a decision. It is entirely possible to switch between operating as a sole trader to a limited company and vice-versa, though it isn’t a decision to be made lightly. Making the leap from one structure to another is a challenge, one best undertaken with the professional advice of an accountant.

What are the differences between a sole trader vs limited company?

A business that is registered as a sole trader or a limited company is very different. Both structures are clearly separate from each other, sporting differences that make them suited to very different needs. For example, registering as a sole trader will effectively merge your personal and business finances. If something goes wrong and your business suffers a major financial hit, this could put your car or even your home at risk. This risk is not present under a limited company, as your finances and your company’s finances are cleanly separate. Conversely, a limited company will require more paperwork than a sole trader, often necessitating the hiring of an accountant.

Pros and cons of being a sole trader vs a limited company

As there are clear differences between working as a sole trader or as a limited company, both structures are quite different in terms of the pros and cons they offer. These pros and cons make it difficult to give a general suggestion, as what works for one business may well not work for another. Moreover, the best structure for a business may change during its lifetime, as circumstances change. In order to make the best decision for your business, you’ll need to consider the pros and cons of both structures carefully.

Pros of registering as a sole trader

Registering as a sole trader is a good place to start for most fledgling businesses. It offers a quick and easy way to get started, and is extremely cost-effective. If you are considering working as a sole trader, the following are some of the key pros:

• Registration is quick and easy – Registering as a sole trader is about as simple as stating your intentions to HMRC. This won’t cost you much outside of your time, and it allows you to start working immediately upon sending your paperwork.
• Small administrative obligations – As a sole trader, you are expected to submit an annual tax return and keep a record of your business’s financial transactions. While the latter might be a nuisance, this administrative burden pales in comparison to other business structures.
• Financial privacy – As a sole trader, you will not be required to register with Companies House. This keeps your financial records private, as records kept with Companies House are available for public viewing.

Cons of registering as a sole trader

Convenience might be the main benefit of working as a sole trader, but it does have its tradeoffs. These include the following:

• Owner liability – As a sole trader, business finances and personal finances are viewed as the same. If your business encounters financial problems, then your personal finances could be at risk. In the event your business can’t pay its debts, you will have to step in, even if you have to sell personal assets to cover the shortfall.
• Tax inefficient – Income earned as a sole trader will be taxed under Income Tax rates. These rates are higher than others, generally resulting in a larger tax bill for sole traders than for businesses working under another structure.
• Possible credibility issues – Some creditors and potential clients will view sole traders as less credible than registered limited companies. This can cause you problems when looking to raise finances or take on work, lessening your opportunities.

Pros of registering as a limited company

Registering as a limited company can be a better option as your company grows and expands. It offers a range of strong benefits, including the following:

• Limited liability – By creating a company, it and its owners are two very distinct entities. This keeps the personal finances of shareholders completely separate from the company’s, while also ensuring legal action against the company does not extend to its shareholders.
• Perceived as more credible – Fair or otherwise, plenty of creditors and potential clients view limited companies as a more credible entity. By incorporating into a limited company, you’ll often find you inspire a bit more confidence in various parties, and might even open up additional opportunities.
• Good tax efficiency – Profits earned under a limited company will be taxed under Corporate Tax rates, leading to a smaller tax bill overall.

Cons of registering as a limited company

Limited companies do offer business owners limited liability and a better tax bill, but these advantages come with drawbacks. These include the following:

• Tougher to get going – Creating a limited company is a more intensive task than registering as a sole trader. You’ll need to submit more paperwork, register with Companies House, and keep quite a few company records. Due to the notable administrative burden, it is often advisable to hire an accountant.
• Less individual control – As part of a limited company, you will often have to compete with other shareholders over the company’s direction. This means you’ll have less control over the company, although this can be mitigated in some respects.
• Less privacy – Limited companies must be registered with Companies House, meaning their financial records are essentially made public.

Which structure is best?

Deciding which structure is best depends heavily on your business and your goals. Both structures have substantial pros and cons, causing them to be more suited to some circumstances than others. Due to ease of registration and less paperwork, being a sole trader is often a good idea for small businesses looking to get started. Conversely, limited companies are often a better idea for larger companies. Limited liability protects shareholders from company debt, while favourable tax rates mean more profits overall. As such, it’s best to carefully consider your situation and obtain financial advice before making a decision.