One of the first major decisions you are likely to make when starting a business is whether to setup as a sole trader or limited company. Put simply, there is no right or wrong answer – the right decision for your will depend entirely on your individual circumstances and the kind of business you are starting.
What you will need to do is look at the pros and cons of both types of business and decide how a sole trader or limited company setup will affect you and what benefits each approach will give you.
Main Advantages of a Sole Trader:
- Less paperwork – you’ll still need to keep records but you won’t have to record as much detail
- Lower costs – because there is less paperwork, you will not need to pay an accountant
- Can be more friendly – some customers prefer dealing with individuals rather than companies
- Faster progress – as there is only one decision maker (you!), progress can be faster and more direct
Main Advantages of a Limited Company:
- Less risk – the company is liable for debts not you!
- Tax efficiency – it is far easier to control how much tax you pay and rates are often more favourable
- Professionalism – a limited company is often seen as more trustworthy and serious
- Financial backing – it’s usually easier to gain loans and investments when trading as a company
With these in mind, most people do find that forming a limited company is a more appealing option. In fact, many people who start off as a sole trader soon switch to a limited company once they begin to grow in size.
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However, if you intend on remaining as a small, local business then you may find the ease of operating as sole trader is the more attractive option.
Before you make your final decision, lets look at some of the key considerations in a little more detail…..
Choosing Your Legal Structure
Keeping Business Records
If you are a sole trader then the records you need to keep are very basic. A simple profit and loss account backed up with receipts and invoices for all income and costs will not only ensure you comply with all the legal requirements but will also help you out when you need to file your personal tax return.
A limited company on the other hand are required by law to keep detailed records of all their transactions and file professional accounts and an annual return every year. Although the annual return is a simple process, most people find they need to employ an accountant to complete the proper financial records each year. This usually comes at a cost of around £400 to £1,000 depending on the complexity of your business.
Limited companies must also maintain statutory books detailing information on the companies shareholders and directors.
Tax and Income
This is where a limited company can offer significant benefits. As a sole trader you would need to pay income tax on the full profit you have earned in a financial year. This will be a simple calculation of income minus costs. There are few options available to reduce the amount of tax you need to pay as a sole trader and you will pay tax at the same rate as everyone else who has a regular job as an employee.
A limited company on the other hand can pay its directors and shareholders a lower standard wage to provide the individual with a fixed wage. The rest if made up by paying a regular dividend, which is taxed at a much lower rate. Usually this will mean you can pay less tax when running a limited company and you have greater control over how much tax you pay. However, you should also take in to account the corporation tax your business will need to pay.
Adding more weight to the limited company argument is the fact it is easier to claim other benefits such as a company car to further reduce your tax liabilities. For most people therefore a limited company will be more tax efficient than being a sole trader.
Shareholders & Investments
If you are looking to gain investments or a loan for your business venture then undoubtedly a limited company has the edge.
For one thing, investors and banks will always be more keen to lend to a proper business than a sole trader, but due to the issuing of shares in limited companies, its much easier to make investment a more attractive option (since investors will gain a share of the profits).
Another consideration is that a limited company is much easier to sell or transfer to a new owner at a later date as they can just take over the issued shares. This also makes it easier to leave your business to a loved one in a last will of testament.
As a sole trader you would be responsible personally for any debts that are incurred. In a worst case scenario this could result in you losing personal possessions including your home. Limited companies are much more appealing in this respect since the company is responsible for its debts and not the people who run it.
Of course this does not give you free reign to run up huge debts as there are laws that help to prevent the limited liability aspect of companies from being abused. However, it does give you peace of mind that even if your venture fails, you will not be forced to lose your property or other possessions.
Perception & Opinion
In any competitive environment, the perception of your business by your customers and clients is key. The type of company you are running will strongly affect the perception you want to give.
For example, a local housing window cleaner may prefer to be seen as a sole trader as this can be much more friendly and personable and may even increase the trust levels of customers.
However a window cleaner who specializes in cleaning windows of large businesses may prefer the impression a limited company gives off of him being a successful and professional operation.
Ultimately it comes down to personal preference, and its important not to spend too much time debating the pros and cons and just get started in making your business a success.
There are advantages and disadvantages to both so just get a feel for which is likely to be best for you and get going. If you decide later you made the wrong decision, you can always take the steps needed to revert back to being a sole trader to to start forming a limited company.