Limited company or sole trader? What to consider before you choose

Should you run your business as a limited company or as a sole trader? 

It’s a simple question without a simple answer. 

There are a number of significant differences between these types of company, and the choice you make will affect how you pay tax, how you organise your business and how you grow. 

So, how do you choose?

Table of contents

• Grow big or stay small
• Separate your business from your life
• Freedom to change your mind
• Insurance is essential whichever option you choose
• The differences, defined
• Ready to start your company?
• Limited company or sole trader infographic

Grow big or stay small

One way to consider this question is to think about the kind of business you want to build. 

If you want to run a small company and work with other small companies or to sell directly to the public, then operating as a sole trader may be fine. You could spend your entire working life as a sole trader – and plenty of people do. 

If you want to start a business that has potential to grow into something big, or work with larger companies, then operating as a limited company might be essential, in part because some large companies refuse to engage sole traders. This reluctance to hire sole traders is because the corporation would technically be engaging an individual, which could entitle the individual to employment rights and benefits.  

If your business involves contracting to large companies, operating as a limited company might be essential to getting your foot in the door. 

On this basis alone, your decision might be made for you. 

Separate your business from your life

Before we examine the differences between these two legal structures, let’s consider one of the big differences, which should help to frame this debate.

If you operate as a sole trader, you are doing business as yourself. You and your business are inextricably linked, because you are one entity. 

If you operate as a limited company, you are the director of a company that is doing business. You and your business are legally distinct entities. 

As you can imagine, creating a distinct legal entity is going to involve more work, and a greater cost than simply doing business as yourself. 

But this extra work brings some benefits, which we will explore shortly. 

Part of the challenge in deciding how to structure your business is comparing the benefits of each model and evaluating whether they have an impact on you and the business you’re building.

Freedom to change your mind

If you start to feel overwhelmed by the different considerations outlined here, remember that your choice is not cast in concrete. 

If you change your mind further down the line, you can change your company. 

Of course, it’s simpler to pick a company format and stick to it, but the difference is a little paperwork and potentially some additional expenses. It’s inconvenient; it’s not impossible.

Insurance is essential whichever option you choose

Although we discuss some of the ways that being a limited company can reduce your liability, and provide some legal protections, insurance is important, regardless of whether you are a sole trader or a limited company. 

Don’t think that you can’t be sued as a sole trader, or that your limited liability is a protection from legal claims. 

Investigate the types of insurance available and consider whether you need professional indemnity insurance, public liability insurance, or employers’ liability insurance, to name a few. 

The differences, defined

There are several significant differences between company types, so it’s important to consider them carefully before you decide. 

If you can, talk to an accountant or a business advisor about your situation and your plans for the future. 

Let’s look at the important differences in legal structures.

Limited companies and sole traders: key differences

• Commitment – it’s a little easier to cease trading as a sole trader
• Liabilities – your liability is unlimited as a sole trader
• Costs – limited companies typically cost more to run
• Tax – there are usually slight tax advantages for limited companies
• Paperwork – limited companies have more obligations to keep and prepare financial records
• Paying yourself – as a sole trader you can withdraw income to use personally. As a limited company, all withdrawals are taxed
• Accountants – as a limited company you will probably need an accountant
• Privacy – sole traders keep their finances private; limited company accounts are public
• Status and stature – limited companies appear more stable than sole traders, and are preferred by large companies and government agencies
• Trading name protection – by forming a limited company you block others from using the same name
• Selling or sharing your business – it is typically easier to split ownership of your company if it is limited, and it may also be easier to sell
• Pensions – limited companies can contribute to the directors’ pensions, whereas sole traders can only have personal pensions
• Coronavirus support – many sole traders seem better served by government assistance programs than limited company directors (particularly directors who paid themselves in dividends)

Let’s explore these differences in greater detail…

Commitment

Is your business brand new? 

If you’re starting a new venture, you may not be 100% sure that the project will work out, or that you’ll enjoy this way of earning a living. 

Operating as a sole trader makes it easier to start and stop. To stop, you would just need to complete your tax return and notify HMRC that you are no longer self-employed. 

Operating as a limited company is a little more involved. To cease trading, you would need to notify all of your trading partners, settle all your debts, collect unpaid invoices, and complete your final set of accounts. 

And because you would likely need the help of an accountant to wrap up your accounts, it is likely to be significantly more expensive to start and stop a limited company. 

This difference is likely to be hundreds of pounds rather than thousands, although it really depends on the accountants you choose and the complexity and size of your business. 

Liability

By forming a limited company, you create a degree of legal separation between yourself and your company. 

This separation doesn’t exist when you operate as a sole trader. 

In practice, this would mean that you are personally liable for a debt you owe through your business operations as a sole trader. If your business got into trouble, you could lose personal assets.  

But if you trade as a limited company, then any debts and obligations belong to the company. You are not personally liable for paying the debts of your company. 

Nobody goes into business with the intention of accruing debt, but problems can arise unexpectedly, and you may appreciate having some legal distance from your company if things go south. 

Costs of doing business

Limited companies usually cost a little more to run, primarily because the accounting procedures are more onerous than for sole traders. 

Sole traders prepare a self-assessment tax return each year.  

Limited company directors must prepare a profit and loss account, a balance sheet, an annual return, and also self-assessment tax returns for the directors. Your company accounts must be prepared according to accepted accounting standards. 

While there’s no legal requirement to use an accountant, and you could theoretically prepare your books and reports yourself, the reality is that learning how to prepare your financial documents would likely take you many precious hours – hours that you could be spending earning money.

Accountants typically charge a few hundred pounds per year (up to £1000+ for a more bespoke service. 

Tax 

In the past, there was a greater difference between the tax paid by limited companies and sole traders. But it seems that the government has got wise to this and tried to narrow the gap. 

While there may be a slight tax advantage if you operate as a limited company, the difference is rarely significant enough to make it a major consideration when you choose how to run your business. 

Paperwork

The consensus is that you’ll be doing more paperwork as a limited company – although the majority of this burden will be shouldered by your accountant. 

You may want to invest in a bookkeeping system to help you manage your money and keep track of invoices, particularly if you will need to pass your financial data to an accountant each year so they can prepare your accounts. 

Paying yourself

Sole traders can pay themselves with any funds available in the business. So, if you earn £2000 building a website for a client, you could transfer the £2000 to your personal account. 

As a limited company, you are taxed when you extract profits. They might be classed as a distribution (dividend) or earnings (salary). 

Although trading as a limited company might sound more complicated, the reality is that you quickly grow accustomed to paying yourself appropriately and understanding the tax implications of each option. 

Accountants

While many sole traders prepare their own self-assessment tax returns each year, very few limited company directors prepare their own accounts. 

As we outlined above, it’s far more likely that you’ll need to pay for an accountant if you go Ltd. Although there are plenty of sole traders who prefer to find an expert to manage their books while they focus on building the business. 

Pro Tip: If you would like to hire an account, learn how to choose an accountant for your small business.

Privacy

Want to know how well your competitors are doing? 

If they are a limited company, you can browse the Companies House website and find a summary of their directors and financial records. Their balance sheets are just a click away. 

Sole traders have more financial privacy. Their self-assessment tax records are not public (unless they happen to leave one on a bus). 

Status and stature

There are some tangible and intangible ways that being a limited company lends you the appearance of permanence and respectability. 

Because it’s easier to start and stop a sole trader ‘business’ – it has less solidity and permanence in the eyes of many potential customers and partners. 

And because your limited company records are public, your customers can conduct ‘due diligence’ by simply checking the Companies House website. 

If appearances are important to your success, either because of your target customer, or because of your plans for the future, then a limited company is probably the right choice. 

However, it’s worth reiterating that millions of professionals operate as sole traders for the life of their company, without experiencing any detrimental effects. 

Trading name protection

Let’s say you create a limited company, and you call it Sally’s Sausages. Nobody else can register a limited company with that name. You get an automatic degree of protection by registering a limited company. 

The protection conferred by forming a limited company is not the same as registering a trademark. Registering a trademark is worth considering if you are planning to build a recognised brand or want to deter companies from using similar identities. 

Selling or sharing your business

Any business can be sold, regardless of whether you are a sole trader or a limited company. 

However, you may find it easier to sell a limited company because the company itself is a clearly defined entity, with a complete evidence trail of its trading history. 

As a limited company, it is also simpler to involve additional partners and shareholders, simply by recording the transfer of shares with Companies House. 

That’s not to say you can’t split or share a sole trader operation; it just happens to be more transparent if you operate as a limited company. 

Pensions

As a sole trader, you can pay into a private pension. 

As a limited company, you have more options. These include the option to have your company contribute to your pension, which is beneficial from a tax perspective. 

The rules are fairly complex, but the key takeaway is that you can build your pension more efficiently by getting your company to contribute – and these contributions are treated as an expense (which therefore reduces your tax burden). 

Coronavirus complications

The British government acted swiftly to help people survive the financial effects of the pandemic. Unfortunately, the package of assistance did not help all people equally. 

While the government’s self-employment income support scheme (SEISS) programme offers money to self-employed people, the calculation is based on your salary from self-employment. 

If you were a director of a limited company, withdrawing your earnings as dividend payments, then you could only claim support on the tiny fraction of your income that was taken as a salary payment. 

This stipulation effectively created a hole in the safety net, causing millions of limited company directors to find themselves with no government support. 

One would assume that the pandemic is a one-off, and that anyone starting a business post-pandemic would adopt a pandemic-proof business model, so hopefully you are unlikely to ever need to rely on government assistance like SEISS.

But it’s worth noting that for this particular crisis, government support favoured sole traders and company directors who primarily paid themselves a salary, and excluded those limited companies who were paying directors in dividends.  

Ready to start your company?

I hope you’ve found this guide helpful. 

While there is a lot to consider, the differences in these legal structures seem to suggest that a limited company is the ideal choice for someone who wants to build a significant company that might deal with larger corporations, and which might, one day, be sold. 

But it’s abundantly clear that the strength and protection you gain from being limited comes at the cost of some freedom and flexibility. There are more rules, regulations and conditions attached to limited company status, although these are all easily managed (as 2,000,000 Ltd companies in the UK can tell you). 

Operating as a sole trader might be ideal for someone who wants to keep things simple, reduce their expenses and administrative obligations, and is less inclined to seek trading partners or buyers. There are definite advantages to being a sole trader, but you have to be sure that you’re comfortable with the limitations of this legal structure.

Whichever option you choose, remember that your choice will not define your success. That’s all down to you (and probably a smattering of good luck). You also have the freedom to change, should your plans change. 

Pro Tip: If you decide to set up your business as a limited company, you can do so with Tide for FREE. You can even opt for a virtual office address as your business address throughout the signup process to keep your personal details private. 🎉

Limited company or sole trader infographic

If you find things easier to digest visually we have you covered. Take a look at our limited company vs sole trader infographic below to get a quick summary of the most important factors to consider before setting up your business.

Header photo by Andrea Piacquadio, published on Pexels