Sole Trader vs Limited Company: How to set up a business.

Summary:

• More and more businesses were created at the start of 2019 in comparison to the previous year, per government statistics.

• Sole traders and limited companies make up the majority of businesses trading in the UK.

• We explain the difference between a sole trader and a limited company and provide a quick step-by-step guide on how to set up a business.

• We have also weighed up the advantages and disadvantages of creating a sole trader or a limited company to help out budding entrepreneurs. We compare both business types to help you decide which one is right for you.

Statistics provided by the government, show that at the start of 2019 there were 5.9 million businesses in the private sector, which was a total increase of 3.5% upon the previous year. 3.5 million of those businesses were made up of sole proprietorships (59% of total businesses), and 2 million were actively trading companies (34% of total businesses).

The rise in the small and medium business population seems to show that more and more people are starting their own business instead of working as an employee. A growing business population could be down to financial reasons such as better pay, or simply because it is an aspiration for some people to open a business and run their own company.

As the most popular business types are sole traders and limited companies, we have put together a comprehensive guide on how to set up as a sole trader or as a limited company. We’ve explored the advantages and disadvantages of both types of business and compared them to decide which business structure is better suited for individuals.

• How to set up a business
• What are the advantages and disadvantages of a sole trader?
• What are the advantages and disadvantages of a limited company?
• Should I setup as a sole trader or limited company?
• Comparing a sole trader vs limited company in detail
• Final Words and FAQs

How to set up a business

What is a sole trader?

A sole trader is where an individual runs their own business and is considered self-employed. The individual has absolute control of their business, including its assets and its profits after tax. A sole trader is personally liable for the business’ debts, meaning personal finance and assets are at risk.

How to register as a sole trader

To set up as a sole trader in the UK, you need to alert HM Revenue and Customs (HMRC) that you pay tax through and register for Self Assessment. You will then have to file a tax return every year. Your responsibilities will include:

• Keeping records of your business’ sales and expenses.
• Sending a Self Assessment tax return every year.
• Paying Income Tax on your profits and Class 2 and Class 4 National Insurance.

To further check the rules, seek the government’s step-by-step guide.

What is a limited company?

A limited company is a private company (private limited company) where the business owner is only liable for the amount of money that they invest. Meaning, that the business owner has limited liability which helps protect their personal assets and finances should they fall into company debt.

How to set up a limited company

To set up a limited company, you need to follow the steps.

1. Choose a name for your business: Ensure that you follow the specifications of Companies House so that your business’ name adheres to the rules.
2. Choose your director(s) and company secretary: Your business must have an appointed director. However, it is not required that you have a secretary.
3. Assign your shareholders and people with significant control: A limited company must have at least one shareholder. A director can also be a shareholder. People with significant control is defined by anyone who has voting rights or owns over 25% of the company’s shares.
4. Prepare a memorandum and articles of association: These are documents that determine rules about how the company should be run; the founding shareholders decide them. The memorandum of association is a legal statement signed by all founding shareholders who agree to form the business.
5. Learn, understand and check what records must be kept: These include detailed records about the company itself, and accounting and financial records.
6. Register your new company with Companies House: You will be instructed to provide a registered office address. You will also have to provide a SIC code which identifies the nature of your business.

For more details on how to set up a limited company, it is advised that you use the government website.

What is the difference between a sole trader and a limited company?

The most considerable difference between a sole trader and limited company is that a sole trader consists of one individual who is personally liable for the business. In contrast, a limited company is an entity in its own right and can have multiple owners who have limited liability.

How can I get help setting up a business?

Despite reading through the government guides and rules, creating a business can still be very confusing and overwhelming if you lack the experience. However, there are professionals at hand who have experience in helping entrepreneurs create their own business.

1st Formations

1st Formations is one of the UK’s leading online company formation agents in the UK. Although that title seems complicated, it means that they’re one of the best when it comes to helping entrepreneurs set up a new business. 1st Formations are able to provide quick and simple online incorporation in as little as 3 hours.

They offer several different packages to help entrepreneurs incorporate their company. We’ve listed a couple of the most popular packages that 1st Formations offer.

Digital Package - £12.99

The digital package is the most basic of the services that are provided, nonetheless it still includes everything you need to get your business started.

• Incorporation of your private limited company with Companies House (including an email copy of your Certificate of Incorporation).
• Free business bank account.
• Free online company manager.
• Free domain name (.com or .co.uk).

Privacy Package - £19.99

The privacy package was created to protect the privacy of your home address. If you don’t have a trading address your home address is used instead. As Companies House is public, it means that your home address is public to anybody who wants to know more about your company. So, this package is for you if you’re concerned about protecting your privacy.

The Privacy Package includes:

• Everything included in the digital package
• Email copy of the company register with first entries.
• Registered office service based in London (WC2) for 12 months.
• One service address in London (WC2) for 12 months.

So if you’re looking for a quick and easy way to set up your limited company, then 1st Formations is the place to go. If you’re still unsure about forming a new company on your own, they also provide a 24/7 customer support number to guide you through the process.

If setting up a business seems right for you, then check out our next section where we look at the advantages and disadvantages of sole traders and limited companies. We then compare both business types, so you can see how they compare on matters you care about.

What are the advantages and disadvantages of a sole trader?

Advantages

1. Complete Control

As a sole trader, you are the boss. Being self-employed allows sole traders to maintain full control of the business, meaning that you can run the business how you want to. There is no influence or bothersome interference from other owners or stakeholders; you make the final decisions.

Having complete control over a business is one of the critical factors for why people become sole traders, as it gives them greater flexibility of running a business.

2. Keep all of your profits

As a sole trader, you can keep all of your business profits after you have paid tax on them. Unlike a partnership business structure where you would have to share profits, as a sole trader, you’re able to keep all of your profits in their entirety.

A higher profit margin is an enticing factor for those who are interested in the monetary rewards of becoming a sole trader.

3. Cheap startup costs

Registering with HMRC is free, therefore setting up and registering as a sole trader is very affordable. Sole traders do not have to register your new business with Companies House, which charges a fee for registering limited businesses.

The additional benefit of not having to sign up with Companies House is that you uphold maximum privacy. Your business details and directors details will not be stored on Companies House’s public database.

4. You can change your mind easily.

People that choose to become a sole trader usually start part-time. They can remain employed and earn money whilst their business begins to find its feet. Once they’re comfortable with the money their sole trader business is providing, they can go full time.

Furthermore, you can still quickly form a limited company as your sole trader business begins to expand and grow. This allows for flexibility and doesn’t seem like such an overwhelming process.

Disadvantages

1. Unlimited Liability

One of the key disadvantages mainly associated with being a sole trader is that you have unlimited liability for your business. Should you owe any debt or a claim is made against your business, your personal assets and finance are at risk.

In a worst-case scenario, this means that you could lose your income and your personal assets, such as your home or car, potentially bankruptcy. There can be little financial protection as a sole trader.

2. Tax limitations

Sole traders are not the most tax-efficient business when compared to limited companies. The more profits you earn as a sole trader, the higher rate of tax you will have to pay proportionally. Therefore, sole traders generally have less flexibility of being able to maximise profits in comparison to limited companies.

3. Problems with securing funding

Securing funding as a sole trader is usually tricky as most traditional lenders, such as banks, are less inclined to offer loans. Sole traders are considered risky due to their business structure, so are often lent less money. It may lead to shorter repayment periods and higher interest rates.

Traditional banks generally prefer more transparency when lending money or looking to invest, to better understand how their money is being spent. Therefore, the private nature of sole traders makes banks more sceptical about lending money.

It is important to note that banks still do lend money to sole traders, it’s just that usually a smaller amount, has a shorter repayment period and can come with higher interest rates. Alternatively, you could apply with an alternative lender to secure sole trader funding or a business loan.

4. More responsibility = More work

As a sole trader, you undertake every aspect of the business, including making the big decisions which ultimately decides whether you earn money or not. As most people want to generate a profit, it requires more oversight and more work which can often strike a poor work-life balance.

Many sole traders may not want to lose business, so they can be more reluctant to take a holiday. Furthermore, nobody is paying for your holiday if you’re a sole trader, which is also another reason why someone running the business as an individual may be less inclined to stop working.

What are the advantages and disadvantages of a limited company?

Advantages

1. Limited Liability

The limited liability of running a limited company is a benefit for many owners. Limited liability ensures that a business owner’s personal assets are protected should their business incur debts. Therefore, you are not required to hand over a house or car if your business racks up a high amount of debt.

It allows business owners to choose whether they wish to use their personal assets to pay off debts should it come to that situation. The limited liability of a limited business offers protection for business owners and directors unless they commit fraud.

2. Greater tax efficiency

Limited companies are very tax-efficient, which is a big reason why someone may opt for a limited business model. Of course, limited companies still pay tax, but the tax rates they pay can be more flexible. Limited businesses usually take the maximum amount of profit that hasn’t been taxed.

The tax advantages of a limited company are an influencing factor for those who wish to utilise them. It is always advisable to speak to a professional to meet regulation criteria before making the most of limited company tax rates.

Below is a table showing how much you can save as a limited company in comparison to a sole trader.

*These numbers are based off Companies Made Simple tax comparison calculator.

3. Professionalism

Limited companies are often treated with much more prestige. In some industries having a limited company reflects a more professional image, this could possibly be because it is registered as part of Companies House. Although not always the case, some big businesses prefer to work with limited companies over other business types.

As a limited company, your business name is protected by law, meaning that no other company can have the same business name as yours. It ensures that your business is entirely individual and means nobody can damage your image by trading under the same name.

4. Raising funding

Securing funding or raising capital as a limited company can be an easier route than a sole trader. Limited companies can offer shares, which can provide capital for the business to expand. These shares are available to current shareholders or new investors.

Also, limited companies can still borrow money from banks. It means that business owners and company directors have more options to choose from when looking for further investment in their business.

Disadvantages

1. Greater complexity

Setting up and running a limited company can be quite confusing for new business owners as it has a more complicated business structure compared to sole traders. It takes more steps to set up and requires registration/incorporation with Companies Houses, which costs a small fee, requiring much more administration.

Furthermore, the account structure of a limited company is also very complicated, with many directors hiring professional accountants to take care of tasks such as tax returns and updating monthly and annual accounts. Hiring an accountant will cost money, but if account reports are not filed correctly or regularly kept up to date, companies can face penalties from HMRC.

2. More costs

The greater complexity of a limited company generates more accountancy and administration procedures. This work is likely to be outsourced to ensure that it adheres to rules and regulations. More administration will likely result in the company having to pay fees to accountants or legal consultants.

3. Lack of Privacy

Limited companies have to be registered with Companies House, which is accessible by anyone via the Companies House public database. There are many details included, such as company accounts, personal details and company structure, i.e. directors, shareholders and persons of significant control.

For those who are looking are concerned about maintaining their privacy, running a limited company will compromise this.

4. Lack of total control

If your limited company has other directors or other shareholders, you will have to accommodate their views and opinions during decision-making processes. The more significant share in the company that an individual has, the more influence they can dictate. If they have a more substantial share than you, they have greater ownership.

If you are the sole shareholder, this means that you own 100% of the company. However, many limited companies have multiple shareholders to help secure funding and to split the workload. So, as your company begins to expand, bringing on an additional shareholder may be necessary.

Should I setup as a sole trader or limited company?

Comparing a sole trader vs limited company in detail

Deciding what business type is better is ultimately down to personal opinion and circumstance. It is a decision that should be thought about carefully, and the pros and cons should be weighed up for both sole traders and limited companies. Some points will outweigh other points, and it’s down to your discretion to decide what is better for your situation.

Building upon the previous information provided in our infographic, we have put together a more detailed comparison table below.

Final Word

Deciding to become self-employed or to start a business is a big step for an entrepreneur to take, and it takes years of hard work. So, it’s always an idea for an entrepreneur to have a well researched and developed plan before they start a business from scratch. You could try talking to entrepreneurs who have experience creating a business or by speaking to a business consultant.

If you need help setting up your new business, contact our partner, 1st Formations. They specialise in helping entrepreneurs set up limited companies, as well as offering a host of accountancy services to help your business perform at its best.