Last Updated: Mar 22, 2021

Sole Trader or Limited Company? Which is Best?

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Sole trader or limited company – which structure is best when you want to grow your business?

If you have been operating as a sole trader for a long while, you may be wondering if it is the right time to incorporate your business and set up your own Limited Company.

For the small business owner, there can be pros and cons to remaining as a sole trader, but also with forming your own company.

Here we are going to look at the pros and cons of both business structures in the hope that it helps you to decide whether it is in your best interests to remain as a sole trader, or if you should take that important leap towards making your business official and give it a more professional edge.

The advantages of forming your own Limited Company

You can set up and run a limited company as one single person. You can be the sole Company Director and shareholder. You can take money out of your company if the form of a salary as well as in the form of dividends – or a mix of both.
When you go through the company formations process, the incorporation to a limited company will provide you with limited liability protection.

This means that your company shareholders will have paid for his or her shares and will not be required to invest any more money into your company.

So should anything bad happen to your company and you need to close it down, your shareholders will not have to pay out to cover any debts that have been run-up in the company name.

A limited company will enjoy legal continuity

Once your company is incorporated, in the eyes of the law it is seen as a separate identity to you. That means that your company can go on to own its own property, buy assets that are owned in the company name, and can also invest its own money and can become a shareholder in its own right by buying shares in another company.

Just like a real person, a limited company can sue another company or a person, and also be sued by someone or by another company.

One of the major benefits of incorporating your business is when you want to set up a company that will last long into the future after you retire from the business.

If you are looking to set up a legacy that you can pass on to your children, then setting up a limited company will ensure that your business will continue to operate should you retire or die. Effective ownership of the company can be readily transferred to others.

A sole trader is someone who is formally recognised by HMRC as being in business for themselves and not for others. So you effectively you are your own business.

As a sole trader, your business will cease to exist once you stop working or you pass away. If you plan on spending many years building up your business, it would be wise to incorporate it so that it can be left to others to run long after your departure.

Businesses assets can act as security

When you have plans to seek out financing to help you expand your business, banks will usually be happy to take extra security against your bank loan in the form of a floating charge over the company assets.

This will mean that you can usually apply for more money to borrow to fulfil your plans for expansion at much better terms.

As a sole trader, you will find it more difficult to secure credit or loans. Plus most business lenders will usually apply higher interest rates, limit the amount you can borrow and may demand a shorter repayment period with less flexibility.

Plans to employ staff

If you are planning to expand your business and to take on extra staff, then as a limited company you will be able to establish an approved pension scheme to enrol your employees into.

Limited Company pension schemes can offer your staff greater benefits compared to what they can get through any self-employed pension plans.

Generating more money for your business

When your business needs a cash injection to help finance a new plan or to replace critical tools or machinery, as a limited company you can offer your employees the opportunity to buy shares in the company and become shareholders.

This will help you to raise the money you need to furnish your plans, but by offering your staff a way to invest in themselves, you can increase the levels of loyalty and give your staff a sense of inclusiveness in their own future and that of the company.

Corporation tax benefits

As the corporation tax rate is comparatively low compared to the level of tax you will pay as a sole trader, it means that more of the profits your business generates can be invested back into your company.

The disadvantages of forming a Limited Company

There will be costs involved in the initial set up of your limited company. However, these are minimal and you can choose the formations package that best suits your needs.

It has to be said that there are more annual administrative costs involved in the running of a limited company than compared to running as a sole trader.

For example, the costs associated with preparing the annual accounts can be greater for a limited company simply because they need to prepare in a way that complies with the requirements set out within the Companies Act.

Income, TAX and National Insurance

As a director of your limited company, you will be taxed under PAYE and you will have higher National Insurance contributions to pay than you did as a sole trader. Your company will also have to pay out employers’ NI contributions.

Company dividend payments do not go towards your pension. Dividends are paid out but are not subject to NI, so they are not classed as relevant earnings towards your pension contributions.

As all of your company shareholders (including yourself) are entitled to a dividend payment, if a dividend is declared, then all shareholders are entitled to receive it.

However, if you have different classes of shares within the company or you have set up a formal dividend waiver, then not all types of shares will pay out a dividend to your shareholders.

Company benefits

As a limited company, there will be much tighter regulations over both employee and director benefits. This is especially true in respect of company cars.

How do I set up a limited company?

To set up your limited company, you will need to register your business with Companies House. However, forming your limited company can be quite confusing and if you submit the wrong information or fail to supply some critical information that Companies House needs to process your request, your application may be rejected.

Companies House need a specific set of details about your new company to go on public display in the official register of companies, including all of the director’s details, which everyone has access to and can look up the details for every company registered in the UK.

By registering your business as a limited company, you will agree to filing an annual confirmation statement and annual company accounts. These documents will be put on display with your company details to meet with UK transparency laws.

You can make it much easier on yourself by using an official formations company to act on your behalf. Your Company Formations offer a range of ‘Limited by Shares‘ options for you to choose from when you want to form your limited company.

This means you can choose the right company formations package that best suits your needs and we will handle absolutely everything for you. You will also find that going through us to form your company is much swifter and cost-effective than trying to handle the process by yourself.

We are not here to tell you that one approach is better than the other. It is up to you how you want to proceed and how you want your business to work going into the future.

There is no simple answer to which way you should go because one size doesn’t fit all. But if you need some help or guidance about forming your limited company, we are here to help!

Feel free to contact our friendly team of formations experts with years of experience of helping thousands of business owners form their own company.