Sole Trader vs. Limited Company – Which Business Structure Fits You?

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When starting a business, one of the first decisions you'll need to make is choosing the legal structure for your company. The two most common options in the UK are operating as a sole trader or forming a limited company.

Whether you’re a freelancer or a tradesperson this choice has significant implications on things like tax, liability, professional image, and growth plans. Making sure you get it right from the outset can save you a lot of headaches and costs down the road.

We'll explore the differences between these two structures as well as the pros and cons of each one. This should help you understand which one aligns better with your specific business goals and circumstances.

Key takeaways

  • A sole trader structure offers simplicity, complete control, and potential tax advantages for lower profits, but comes with unlimited personal liability and limited access to funding.
  • A limited company provides limited liability protection, enhanced credibility, and better access to capital, but involves more administrative work, higher costs, and greater scrutiny.
  • Taxation considerations, legal and compliance aspects, and growth potential are crucial factors to evaluate when choosing between a sole trader and a limited company.
  • Consulting with professionals, understanding your goals, and regularly reassessing your business structure as your venture evolves can help ensure you make the right choice.

Understanding sole trader setup 

A sole trader is the simplest way to run a business in the UK. It means you're self-employed and operating the business as an individual, without creating a separate legal entity like a limited company. As a sole trader, you're in full control of all business decisions and operations.

Advantages of being a sole trader

  • Easy setup and less paperwork: Becoming a sole trader is quick and hassle-free, with minimal administrative requirements. You can start trading immediately after registering with HMRC, saving you time and money.
  • Complete control: As the sole owner, you have the flexibility to make all decisions about your business without consulting partners or shareholders.
  • Keep all profits after tax: You're entitled to keep all the profits generated by your business after paying taxes. This can be especially beneficial in the early stages.
  • Potential tax benefits for lower profits:  In some cases, being a sole trader can be more tax-efficient, especially when your business profits are lower. First-year losses can even reduce other taxes you owe, potentially resulting in a refund.

Disadvantages of being a sole trader

  • Unlimited personal liability: The major downside is that you have unlimited personal liability for any debts or legal issues related to your business. Your personal assets, like your home or savings, could be at risk if your business faces financial difficulties or legal claims.
  • Limited access to funding: As a sole trader, you're solely responsible for financing your business, which can make it challenging to access capital or resources for growth or tough times.
  • Difficult to transfer ownership: It can be harder to pass on your business through inheritance or sale compared to a limited company structure.
  • Some clients may prefer limited companies: Some potential clients or partners may prefer to work with limited companies rather than sole traders.

The limited company advantage

A limited company is a separate legal entity from its owners (shareholders). It's an incorporated business structure that provides protection to the owners' personal assets. This means the company's finances are separate from the individuals running it.

Advantages of being a limited company

  • Limited liability protection: The top advantage is that it protects your personal assets, like your home or savings, from the company's debts or legal issues. Your liability is limited to the amount you've invested in the business.
  • Enhanced credibility: Having a limited company can give your business more credibility and a professional image, which can be attractive to potential clients, investors, or partners.
  • Easier access to funding: As a limited company, you can raise capital by selling shares or seeking investment, which can provide the funds needed for growth and expansion.

Disadvantages of being a limited company

  • More administrative work: Setting up and running a limited company involves more complex paperwork, accounting, and reporting requirements compared to being a sole trader. 
  • Higher costs: In addition to the initial incorporation fees, limited companies typically have higher ongoing costs, such as accounting fees and annual compliance fees paid to Companies House.
  • Greater scrutiny: Limited companies are subject to more oversight and reporting requirements, including filing annual accounts and confirmation statements with Companies House, which are publicly available documents.

Taxation considerations

Sole trader

As a sole trader, you don't pay tax on your business profits separately. Instead, your business profits are treated as personal income, which is then subject to income tax rates based on your total earnings for the year.

One advantage of being a sole trader is that you can claim allowable business expenses, such as equipment, travel costs, and home office expenses, which can reduce your taxable income and the amount of tax you owe.

Limited company

Limited companies are separate legal entities, so they pay corporation tax on their profits at the applicable corporate tax rate. For the 2024 tax year, the rates are as follows:

  • Small profits rate (for companies with profits under £50,000): 19%
  • Main rate (for companies with profits over £250,000): 25%

As a shareholder-director of a limited company, you can take a combination of salary and dividends. Salaries are subject to income tax and national insurance, while dividends are taxed at lower rates than income tax, providing potential tax planning opportunities.

Additionally, limited companies can claim various tax reliefs and allowances, such as capital allowances on certain business investments, which can help reduce their overall tax liability.

Legal and compliance aspects

Sole trader

Sole traders have unlimited personal liability. This means you're personally responsible for any business debts or legal issues. If something goes wrong, your personal assets like your home or savings could be at risk.

To start as a sole trader, you'll need to register with HMRC for Self Assessment and let them know when you start trading. You'll also need to choose a business name – it should be unique but can't be offensive or include 'limited' or 'Ltd.'

Limited company

One of the main advantages of a limited company is the limited liability protection it provides. The company is a separate legal entity, so your personal assets are generally protected from business debts or legal claims against the company.

To form a limited company, you'll need to register with Companies House and submit various documents, such as the memorandum and articles of association. This process involves filing fees and legal formalities.

Once incorporated, there are ongoing compliance requirements, like filing annual accounts and confirmation statements with Companies House. Directors also have legal responsibilities, such as acting in the company's best interests and avoiding conflicts of interest.

Here are our top tips if you want to set up a limited company:

  • Seek professional advice from an accountant or lawyer when setting up a limited company to ensure you comply with all regulations.
  • Stay on top of deadlines for filing accounts and other documents to avoid penalties.
  • Understand your duties and obligations as a company director to mitigate legal risks.
  • Maintain clear separation between company and personal finances for liability protection.

Flexibility and growth potential

Sole trader

An advantage of being a sole trader is that you have complete flexibility in how you run your business and make decisions. You don't have to consult with partners or shareholders, which can mean quicker decision-making and adaptability.

However, this flexibility can also be a double-edged sword. With limited resources and access to funding, it can be challenging to scale your business and take advantage of growth opportunities that may arise as you’re relying on your own financial resources and reinvesting profits back into the business.

Limited company

Limited companies have a higher potential for growth and expansion. By separating the business from personal assets, it's easier to attract investors or secure loans to fund growth plans.

As a limited company, you can sell shares to raise capital, making it easier to finance new projects, hire additional staff, or expand into new markets. The limited liability structure also provides more credibility and confidence for investors.

Additionally, the ability to retain profits within the company can provide funds for reinvestment and growth. You’re more likely to be accepted or a business credit card with this structure too. The Capital on Tap Business Credit Card offers 1% cashback on all card purchases, which you can redeem for cash, gift cards, or against your balance.

Overall, the limited company structure offers more opportunities for scaling and taking your business to the next level.

The bottom line

Deciding between operating as a sole trader or a limited company is a crucial choice that will significantly impact the trajectory of your business venture. While there is no one-size-fits-all solution, carefully weighing the pros and cons of each structure against your specific goals and circumstances will help you make an informed decision.

If you value simplicity, flexibility, and potentially lower costs, particularly in the early stages of your business, being a sole trader could be the ideal option. However, if you seek limited liability protection, enhanced credibility, and greater opportunities for growth and funding, forming a limited company might be the better path.

Ultimately, the choice between a sole trader and a limited company is a personal one that depends on your risk tolerance, ambitions, and long-term vision for your business. Seeking professional advice from accountants or legal experts can also provide valuable guidance to help you navigate this important decision.

This does not constitute financial advice. Please consult an accountant or financial advisor if you would like more information. 

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