When I recently decided to register The Frangipani Creative, I was wondering what type of entity it should be. My Chartered Accountant explained my options and explained the difference between sole trader versus limited company. Let me try to explain them to you.
Sole Trader versus Limited Company : What’s The Difference?
If you’re thinking about starting your own business then there are a few options available to you. The two most common options are to set up as a sole trader or to register as a limited company. Both of these options have their own sets of benefits and drawbacks which can make it quite difficult to decide which will be best for your business. Here I’ll quickly highlight what the differences are between a sole trader and a limited company and then outline what you can do next.
What is a sole trader?
A sole trader (sole proprietor) is possibly the simplest business structure and this may help to explain why it is also the most popular. As a sole trader, one person owns and runs the whole business making this business structure great for freelancers.
What is a limited company?
A limited company can be owned by one person or multiple people and is one that has its own legal identity that is separate from the business owners. This means that the companies owners and shareholders are not personally liable for any business losses.
There are actually two types of limited company, private limited companies and public limited companies. Private limited companies cannot give shares to the general public and are the most popular option for small businesses. Public limited companies can raise their capital by selling shares to the general public, but to trade on the stock exchange they must have issued shares to the value of £50,000 making this structure most common for larger and more established businesses.
What are the benefits of being a sole trader?
- Setting up as a sole trader is very easy and involves very little paperwork
- A simple tax return is submitted each year
- The owner’s personal details are kept private as opposed to being published on Companies House
What are the drawbacks of being a sole trader?
- Investors and banks tend to favour limited companies when offering financial support
- Some larger clients prefer to deal with limited companies
- Sole traders have unlimited liability meaning that if their business gets into debt they are personally liable
- When you reach a certain earnings bracket the taxes imposed on sole traders are not as favourable as those for limited companies
What are the advantages of a limited company?
- The personal assets of the owners aren’t exposed if the company gets into debt due to the benefit of limited liability
- There are a wider range of tax-deductible costs that aren’t covered by sole traders
- Limited companies can be more profitable as you will pay corporation tax rather than income tax on your profits
- Once you have registered as a company no one else can use the name
What are the disadvantages of a limited company?
- Limited companies have more responsibility than sole traders and there’s more paperwork to file and return
- The finances of a limited company are more complex and therefore many hire an accountant which can be costly, alternatively managing the accounts yourself can be time-consuming
- Information on your business can be found through Companies House including your earnings
How do you set up as a sole trader
You can earn up to £1000 in a given tax year as self-employed before needing to register as a sole trader. Registering as a sole trader is extremely simple and involves filling out an online form and registering for on the GOV.UK website, you will then need to fill out a self-assessment annually.
How do you set up a limited company?
Setting up a limited company yourself is fairly easy but choosing a company formation agent can make it even easier. If you choose to set up the limited company yourself you will need to register with Companies House, this is called incorporation. When registering, you will need to provide the registered name and address of your company in full, the names and addresses of any directors and details of shareholders and capital.
So which should you choose?
The decision as to whether you should register as a sole trader or a limited company is a tricky one and largely depends on the amount of profit you will be making and the paperwork you are willing to fill out. If you can, speak to an accountant about your options and share with them your business accounts so that they can advise you on the best route to take. If you do decide to start as a sole trader you can always switch to a limited company at a later date.