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Why do business owners choose to incorporate?

Why did you decide to set up your own company, rather than become a sole trader? A new piece of research from HMRC, based on interviews with 1,000 small business owners, shows what motivated people to incorporate – and what their priorities were before and after they started trading.

Why did you incorporate?

Traditionally, on business sites like ours, guides usually highlight the main benefits of incorporating as a) the limited liability of directors, and b) the tax efficient nature of limited companies compared to other ways of working.

HMRC Research Paper 317, carried out by Ipsos MORI, asked a large group of business owners a number of questions about their experiences of the company formation process, and how they felt about running a company.

Of particular interest to us was what motivated people to choose the limited company route, rather than the sole trader option. There are currently around 1.4 limited companies in the UK, compared to 3.5 sole traders and partnerships.

Why did you incorporate your business?

The most common reasons cited by respondents, before they started up were:

  1. The protection afforded to them by the limited liability a company offers (24%).
  2. Tax savings – in terms of personal income tax, plus National Insurance savings on dividend income (19%).
  3. To enable business owners to comply with the terms of any contracts they need to enter into (15%).
  4. Enhanced credibility of working via a limited company (13%).
  5. Provision of a formal structure to trade under (12%).

The benefits post-incorporation – how did attitudes change?

Having already formed a company, the priorities of respondents changed a fair amount – with the credibility element, in particular, highlighted as a key benefit of incorporating. The limited liability element appears to be less of an important benefit to those who have already started working via a limited company.

  1. Enhanced credibility / improved reputation (22%).
  2. Tax savings (20%).
  3. Limited liability (17%).
  4. Compliance with contract criteria (14%).
  5. Providing a formal structure (13%).

What are the disadvantages of incorporating?

People often cite the ‘additional paperwork’ they have to deal with as limited company directors, compared the ‘hassle free’ nature of becoming self employed, when describing the disadvantages of becoming company directors.

In the HMRC research, many business owners didn’t forsee any drawbacks to incorporating their businesses.

Of those business owners who did point out disadvantages, they revolved around two main areas:

a) The increased paperwork and administration (dealing with Companies House, etc.)

b) The higher start-up and ongoing costs of running a company – including accountancy fees.

Tellingly, the research found that there was a correlation between turnover and the extent to which business owners saw administration as a burden, i.e. the more successful a company, the less likely its owners were to complain about the amount of paperwork they had to deal with.

Further reading

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