When starting a business, choosing the right structure for your situation is one of the first key decisions you will make. The two most common options in the UK are operating as a sole trader or starting a limited company. Each has its own advantages and understanding the difference is essential in making the best decision.
What is a sole trader?
A sole trader is the simplest way for a business to operate. It involves running the business as an individual, and as a result you are personally responsible for all aspects of the business, including assuming liability for any debt the business may incur.
Advantages of operating as a sole trader
Operating as a sole trader has a number of benefits, including:
- Easy to set up and start trading
To operate as a sole trader, you must first register with HMRC for tax purposes. This is a straightforward process which is relatively easy to complete. Once this is done, the trade can commence.
- Lower administrative requirements
When compared to operating a limited company, operating as a sole trader involves considerably less reporting requirements, and as a result admin work can be less time consuming and incur fewer costs (depending on the size and complexity of the trade).
- Full control
Sole traders operate without shareholders, and as such a sole trader retains complete control of the business and decisions are made without the need for third-party approval.
- Retain all profits
Income tax is paid on profits exceeding the annual allowance, and National Insurance (NI) is paid on profits over the NI threshold, however after this has been paid, any residual funds can be used by the individual freely.
Disadvantages of operating as a sole trader
While sole tradership has many advantages, there are some key considerations in the decision making process. These include:
- Unlimited liability
When operating as a sole trader there is no legal distinction between yourself and the business. As a result, you are personally responsible for all debts and any potential legal liabilities that may apply to the trade.
- Higher tax rates
Sole traders pay income tax and National Insurance on all profits, which may result in higher taxation than would be incurred through a limited company where corporation tax would apply followed by remuneration from a company which can be planned and decided by the director(s) and shareholders.
- Limited growth potential and access to funds
Investors and institutions can be hesitant to lend to sole traders, and therefore raising capital or expanding the trade may under some circumstances prove challenging.
What is a limited company?
When forming a limited company, you are setting up a separate legal entity. This provides the owner with financial and legal protection from the activities of the trade.
Advantages of a limited company
Operating as a limited company comes with several benefits. These include:
- Limited liability
As creating a limited company creates a separate legal entity, your personal assets are protected as the company is responsible for its own debts and liabilities that may apply.
- Tax efficiency
Corporation tax is typically lower than personal income tax rates (which starts at 19% up to 25%). As a result, you may find that setting up a limited company may be a more tax efficient business structure when considering that dividend rates are lower than the rates for the tax of income through a sole trade.
- Credibility and professionalism
Investors and clients may view limited companies as more reputable, with a more professional image.
- Easier to raise finances
Investors and lenders may prefer to do business with limited companies than with sole traders which can make access to finance easier as well as potentially access to lower rates of interest for certain types of lending.
Disadvantages of a limited company
As is the case with sole traders, there are several considerations which must be made when deciding whether to set up a limited company. These include:
- Greater administrative burden
Limited companies are subject to greater regulation than sole traders, and annual company accounts must be filed with Companies House. A company must also file a Corporation tax return with HM Revenue & Customs for every set of accounts that are filed. Accountant costs are typically far higher for limited companies than they are for a sole trade set of accounts.
- Less privacy
Although accounts that are submitted to Companies House are filleted and show a far reduced set of financial information (typically balance sheet and certain disclosures), certain aspects of the business’s finances remain available to view by the public.
- Higher set up costs
A company must be formed with Companies House which can be done yourself, although many people will ask an accountant to do this to ensure the information is accurate and the structure of the business is correct. There is a cost associated with the formation.
Which structure is right for you?
Deciding on the correct business structure is entirely dependent on your individual circumstances. Your business goals, long-term aims, current financial situation and appetite for risk are all factors that come into consideration.
If you are aiming for simplicity, do not plan on extensive growth and wish to have immediate access to all profits, operating as a sole trader may be preferable. However, if you’re targeting substantial growth, wish to reduce your personal risk and prioritise tax efficiency over financial availability, forming a limited company may be the best option.
Should the sole trade grow to a size where a limited company would make sense, the trade can always be transferred into a corporate structure at a later date.
At Cooper Associates Accountancy, we specialise in guiding clients through the choice of structure and can discuss each option when considering your aims and objectives together with the detail of the business you will be running. Whether you’re an entrepreneur setting up a business for the first time, or an experienced owner considering a corporate structure, our experts can provide tailored advice to suit your specific needs.
Get in touch today to discover how our team of expert accountants can help you take the next steps in your business venture.
