When starting a small business, one of the first things to be decided is the legal structure used for the business. It can either be a sole trader or limited company or a partnership. Setting up as a sole trader is the most popular legal structure in the UK, with approximately 3.5 million sole proprietorships in 2019. Sole traders accounted for 60% of small businesses in the UK. There were also 1.9 million limited companies, making it the second most popular legal structure.
Even though sole traders are the most popular option for the small business owner, there are clear benefits and advantages of having a limited company over becoming a sole trader.
Here is why a limited company structure may be better for you than becoming a sole trader.
One of the biggest benefits of having a limited company structure instead of operating as a sole trader is that with a limited company you have limited liability. If you want to operate as a sole trader, you will be completely responsible for your business and its finances. As a sole trader, the business owner and the business are treated as one entity. Whereas, with a limited company the business itself is a separate entity in the eyes of the law. If you have business debts as a sole trader or your business goes bust your personal finances and assets are in danger. This is because legally there is no difference between your assets and the business’ assets. Therefore, it’s better to create limited liability as your personal finances and assets are protected should there be problems with the business finances.
As well as your finances, you will need to keep in mind any legal disputes. If you are a sole trader then you will need to make sure that you have various different small business insurance policies in place to avoid getting sued personally. As in the eyes of the law, you and your business are the same, without insurance, you will be sued personally. Another benefit of having a limited company is that you won’t be personally sued as the company is a separate entity.
Another very prominent advantage a limited company has over sole traders is that operating your business through a limited company is more tax efficient. This is because a limited company owner only has to pay corporation tax and dividend tax. Whereas a sole trader will have to pay tax on all of the profits that are above their personal tax allowance (£12,500 for the tax year 2020/21). However, the dividend changes in 2016 do mean that the differences between limited company and sole trader tax are now fewer.
The main disadvantage of having chosen a limited structure rather than a sole trader is that as a limited company owner you have to prepare annual accounts. These need to be filed with the Companies House. You will also need to file a full corporation tax accounts for the HMRC. Whereas, if you are a sole trader you are under no obligation to actually file any of the accounts that a limited company owner has to.
As a limited company owner, you need to make sure that you seek the help of a limited company accountant to ensure that your accounts are thorough.
A limited company may come across to businesses as a better model to work with than a sole trader. This again links back to the limited liability of a limited company. Businesses, contractors, clients etc. are more likely to work with a limited company as their perception is that a limited company is more professional. A limited company can build a good reputation, which makes it more credible to any parties which want to work with your business.
A sole trader legal structure for your business is the easiest to set up and that’s why it has been proven to be such a popular option. However, there are clear advantages to running your business through a limited company structure. Before making a decision, it’s important that all factors are considered. Ensure that you have weighed up the pros and cons of all legal structures to see what fits you and your business best.