Sole trader vs limited company. Which is better?

When starting a business for the first time, most people start as a sole trader, which simply requires registering as self employed. But as businesses grow, they often register themselves as a limited company – for both legal protections and a more preferable structure.

Table of contents

• What’s the difference between a sole trader and a limited company?
• Is it better to be a sole trader or limited company?
• Advantages of being a sole trader
• Disadvantages of being a sole trader
• Advantages of being a limited company
• Disadvantages of being a limited company
• Starting your own business

What’s the difference between a sole trader and a limited company?

The main difference between being a sole trader and a limited company is that as a sole trader, you will operate as one legal entity. As a limited company, your business will become a separate legal entity, which is apart from both its shareholders and directors.

Is it better to be a sole trader or a limited company? 

There is no better option, and you may benefit from either, depending on the size of your business and how you operate. 

There are a number of benefits to both, and the choice you make will affect how you pay tax, how you organise your business and how you grow. 

Remember that you can change your mind at any time, and your choice is not set in stone. Companies can transition from being a sole trader, to a limited company, and then back again. This may incur some extra business expenses, but is entirely possible.

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

Here is an overview of the advantages and disadvantages of being a sole trader and a limited company.

Advantages of being a sole trader

Being a sole trader is often the first step that people take into running a business. In the UK, it is currently the most popular form of business – according to Gov.uk, there are currently 3.1 million sole traders registered.

Easy to start & stop

As being a sole trader only requires doing a self assessment tax return, you can start as a sole trader straight away. This also makes it easier to cease trading as a sole trader. If you decide to stop being a sole trader, you just need to complete your tax return and notify HMRC that you are no longer self-employed. 

Paying yourself

As a sole trader, you can withdraw income to use personally. So for example, if you earned £2,000 building a website for a client, you could transfer the £2,000 to your personal account straight away. Remember that you are still taxed on this amount, so it’s important to set money aside. 

Privacy

Sole traders can keep their finances completely private. Your self assessment tax records are not publicly available, unlike those of a limited company.

Disadvantages of being a sole trader

Once you have become a sole trader, and start establishing your business, you may begin to realise that while it has many advantages, there are some limitations.

Liabilities

As you are operating as one legal entity, this means that as a sole trader, your liability is unlimited. This means that you are responsible for your business, can be sued personally, and are responsible for all debts.

Status & Stature

Limited companies can appear more stable and established than sole traders, which can be essential if you’re trying to attract investors and new businesses.

Some companies will not trade with sole traders, as they would technically be engaging an individual, which could entitle the individual to employment rights and benefits.  

Taxes & pensions

Sole traders can also only have personal pensions, whereas limited companies can contribute to the directors’ pensions as a business expense.

As a sole trader, you can’t leave profits in the business, and you must declare all your earnings as income, whereas a limited company can.

Advantages of being a limited company

Often once a company starts to grow, individuals will make the transition from being a sole trader to a limited company. Being a limited company holds a number of benefits.

Tax advantage

Sole traders pay 20-45% income tax, compared to limited companies, who will pay their taxes through corporation tax, which from April 2023 is 19% (for companies with profits under £50,000) and 25% for those above 

Limited companies can choose to receive payment with a mixture of salary and dividends. As dividends have a lower tax rate to salary and are not subject to national insurance, businesses can adapt their earnings to be more tax efficient, and therefore gain a slight tax advantage.

Trading name protection

Forming a limited company means that you also protect the name, and prevent any other businesses from registering a company under that name. You can check if your desired company name is available via our company name checker.

Credibility

A limited company, with its own protected name, will gain credibility to investors and other businesses, and potentially even access to greater funding.

Selling or sharing your business

As a limited company, it is significantly easier to split ownership of your business as you can allocate shares. Your business may also be easier to sell as a complete package.

Disadvantages of being a limited company

A limited company has huge advantages, but there are some risks to setting up as a limited company too early or if it is not necessary. You should consider the following points below before you register as a limited company.

Costs & complexity

Typically, limited companies are more complex to run, and as a result, may incur further costs such as accountancy fees.

Paperwork & accounting

Limited companies have a much greater obligation to keep and prepare financial records, and as a result, organisation can be much more difficult. For this reason, some businesses choose to hire an accountant to make sure that their finances are in check. 

Starting your own business

Starting a business can be complicated, so we recommend carefully assessing your situation and what might be best for you. 

With Tide, you can set up a business in minutes, with a bank account and all the business tools you need. 

If you decide to set up your business as a limited company, you will need to register the company on Companies House. Normally, this will cost you an incorporation fee of £12, but you can register with Tide completely 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. 

If you’re unsure of anything else about starting and running your own business, check out these 9 steps to starting your business in the UK.