Sole trader or limited company?

by Startacus Admin

When starting a business there are so many things that need your careful attention, from deciding what business to start to creating a functional working environment, to creating your business plan, there are many important decisions to make. Not least of these major decisions is deciding what the legal structure of your business should be.

This is often referred to as your business trading vehicle, which sounds much more complicated and corporate than it actually is. Basically it describes how the business, and your relationship to it is categorised for official purposes. It is a very important decision that needs a lot of careful consideration, because ultimately the trading vehicle that you choose for your business will impact on a great many things. Some areas in which the legal structure of your business plays a key determining role included some day-to-day operations, laws / legislations, and many of the taxes and charges that are payable.

So where to start?

There are many different legal structures to choose from and these range enormously in complexity. Some of them include; Sole trader, limited company, business partnership, community interest company, franchise etc.

The important thing to remember is that the decision you make is not etched in stone for all eternity; you may alter your status further down the line. For that reason, most people opt for the least complex option which is available to them at their current stage, with the intention of growing into more complex categorisations, as a when needed.

With this in mind, there are really only 2 of these legal structures that the average startup needs to concern themselves with; sole trader and limited company.

Sole Trader

This is the simplest, fastest, cheapest and (unsurprisingly) most popular way of registering a new business. It is most commonly used by freelancers and people operating businesses with a fairly modest turnover, for example small shops, hairdressers, business consultancies, and many digital services.

It is a simple set-up because as far as taxation is concerned, your profits are taxed at the rate which those of a standard employed person would be i.e. 20% on anything from £10,600 to £42,385 per annum, 40% on anything thereafter up to £150,000, and 50% for anything above that.

On the flip-side of the coin, in the eyes of the law, you and your business are indivisible from one another. This means that there is no limited liability applied, and therefore your personal assets and wealth are at risk, should your business have any outstanding debts it cannot pay.

Those of the two major characterising features of the sole trader structure, but there are also a number of other benefits and limitations to take into consideration.

The Benefits

• Limited amount of legislation and paperwork

• It allows you to maintain full control of your business without the interference of others such as a company board of directors

• You are able to hold on to all of your profit after taxes, rather than have it circulated back into the company

• Your personal information is not automatically placed in the public domain as it is if you register as a limited company

The Limitations

• Significant liability; You and your business are one and the same, meaning your personal assets are put at risk by any trading that you do

• Being a sole trader can make it more difficult to secure capital for the expansion of the business, meaning that significant fast growth can be hard to achieve

• The business ‘dies with you’; it cannot be officially passed on to anyone else.

Limited Company

This is a more complex vehicle than ‘sole trader’, but provides particular benefits and protections which make it a favourite choice for more established, higher trading companies.

Basically a limited company is an organisation that you establish to take official care and responsibility for the legal and financial aspects of your business. Its major benefit over the sole trader model is that it removes your personal financial and legal liabilities for the operations of the business, hence the ‘Limited’ portion of the title.

This is the major reason why most businesses become limited companies once they reach a certain size; a bigger size usually means an unacceptable level of personal liability involved in the sole trader model.

One of the major difficulties associated with this legal structure is that it is much more complicated than its counterpart;

The Benefits

• Limited liability means you can rest assured if the business goes down, you won't go down with it

• It makes it possible to pass your business on to someone else if you die or are unable to continue working

• In terms of business costs, on average limited companies are subject to a much lower rate of tax than a sole trader is, because they are not applicable for the higher rates of income tax that an employee is.

• You can receive your salary in the form of shareholder dividends, which are taxed at a much lower rate of 10%

• You can register your company name, protecting it and helping you to establish a more visible presence within your particular industry

• Cash can be raised by sharing shares in the company

• You can find all the taxation information you will need as a limited company on the HMRC website

The limitations

• Certain administrative duties such as bookkeeping and accounts become several times more labour intensive in a limited company. This can become costly if you need to use an accountant

• Limited companies generally will have a number of people on their board meaning that the power the original founder has over the future of the business is reduced somewhat

• You lose a significant level of financial control, as profits now become the property of the company, rather than yourself.

Which should you choose? The choice is up to you, but be sure to spend some time examining all of the angles that you need to, before making the decision.

Your first port of call for important issues like this should always be HMRC (They are the ones who make the rules!)

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Published on: 30th April 2015