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Choosing a Trading Structure: Sole Trader or Limited Company?

If you're running your own business or thinking of starting one up, deciding which trading structure to choose is always a bit of a puzzle!

There are pros and cons to both trading as a limited company and as a sole trader, but the most critical factor is to understand precisely what it means, and what your obligations are as a business owner. 

To help decipher the differences so that you can make an informed decision, SAS Accounting has created a quick-fire guide to identify the core considerations, before you make your final decision.

Should you need more assistance, or have a complex scenario where professional advice would be helpful, please don't hesitate to get in touch!

Choosing Company Structure

Types of Sole Trader Business

Many businesses start as a sole trader. This is the same as being self-employed and means that you are one person, carrying on a trade as an unincorporated company.

Popular sole trader businesses include sectors such as:

  • Freelancers
  • Contractors
  • Construction professionals
  • Independent practitioners

There is no golden rule - you can start trading as a sole trader, and keep this same trading status for the foreseeable future. Alternatively, if your business grows, you might decide to incorporate it and become a limited company.

Likewise, you can start a new business and register a limited company from day one.

The right choice all depends on the type of business, your financial circumstances, and what factors are most important to you in controlling and managing how you trade.

Ltd Companies vs Sole Traders: The Key Differences

When it comes to understanding the differential between these two trading structures, the main point is that a limited company is a separate legal entity from you; the individual who owns the business.

Generally, the structure will include:

  • Shareholder(s) - you can be a sole shareholder owning 100% of the business, or the company can be owned by several individuals, all with respective proportional ownership.
  • Director(s) - you might have one director or multiple directors with different areas of responsibility. The directors carry out the day-to-day business on behalf of the shareholders and are responsible for all the crucial decisions and operations.

You can be both a shareholder and a director, but should always know what the fiduciary responsibility of being a registered director entails.

Contrastingly, a sole trader is not an incorporated business (i.e. registered as a separate legal entity with the authorities). This means that you run your business as a single person.

There isn't any need to register the business anywhere - aside from letting HMRC know if you are newly self-employed - and you don't need to appoint directors, or think about sharing ownership of the business with your partners since you're trading by yourself.

Being a Sole Trader - Pros and Cons

You're probably thinking that being a sole trader sounds like a much simpler solution! The reality for a lot of small businesses is that this is true.

However, the big thing to consider is that you are liable for the debts and obligations of the business. There isn't any separation between you and the company, so if you owe money, your creditors can chase you directly to recover this.

Advantages:

  • You'll need to do less admin. The company doesn't need to be registered, and the only return you will need to make is your self-employed tax return at the end of the year, declaring the profits you've made and need to pay tax on.
  • Keeping your accounts is easier, without needing to calculate dividends, for example. It's always essential to keep good records or use a bookkeeping service if you need help to stay on top of your figures.
  • The business affairs are private, and you won't need to publish any public information about your trading income, as you do with a limited company.

Disadvantages:

  • There isn't the credibility that comes with being a business registered with companies house, and you might find it more challenging to open trade credit accounts or apply for business financing.
  • You are responsible for the debts of the business and are personally liable if anything goes wrong.
  • As a sole trader, you won't have access to some of the tax-efficiencies available to a limited company. You will need to be aware of the rules around what expenses are eligible to be deducted from your income before your income tax is calculated.

Registering a Limited Company - Pros & Cons

A limited company means that you have registered with Companies House, and with HMRC. The main downside is that these registrations carry rules about filing accounts and records, although you will now have a degree of separation from the business.

Unless you sign any personal guarantees against borrowing, your personal finances are kept separate from the company, and you won't be at risk if the business gets into debt.

Advantages:

  • Your liability is restricted since a limited company is legally separate from the owner(s). That means that your assets - such as your home - cannot be taken to repay company debt unless you have used them as a security guarantee.
  • There is a more significant potential to make profits since the allowances for business expenses are less strict than for sole traders. Any expense incurred for the company can be written off as an expense.
  • As a limited company, you will have information filed with Companies House, which makes it easier for lenders to credit check you, and therefore easier to access lending.
  • Many business owners decide to incorporate for the credibility and authenticity this lends; clients or suppliers can look up your business online for assurance that the company is officially registered.

Disadvantages:

  • It can be trickier to work out the most tax-efficient way to pay yourself. You can claim profits as dividends, pay yourself a salary, and claim back expenses such as mileage from the company. Many directors use a professional accountant to help them understand the ideal pay structure to avoid incurring unnecessarily high tax obligations.
  • You will be required to adhere to filing rules. These include submitting a set of accounts at the end of each financial year, and other returns such as annual confirmation statements, VAT returns if you register with HMRC (or are required to at a certain level of trading) and Corporation Tax returns.
  • The trading information is public; although how much detail is shown depends on the size of the business and whether you are required to have your accounts audited by an independent professional. If you've had a bad trading year, this information will be published along with statements from good trading periods.

Now you know the pros and cons of each trading option, we hope this makes it easier to decide on the best company formation structure for your business!

If you need any help, advice or assistance, feel free to give our friendly team a call, or drop us a message, and we'll have a chat about your business and which option would be most advantageous for you.

SAS Accounting is a full-service accountancy practice serving clients in the Essex area and beyond. We provide comprehensive advisory support, digital bookkeeping services, and look after all types of businesses to ensure their finances are well managed.