When starting a business, one of the most important decisions you’ll make is choosing the right structure.
The two most common options are acting as a sole trader or incorporating a limited company.
Each has its own advantages and disadvantages, and the right choice for you will depend on your specific circumstances and goals.
It’s worth mentioning upfront that you’re not ‘locked in’ to one another. You can start a business as a sole trader and then form a company, which is a common pathway to entrepreneurship and business-building.
Read on to learn about sole traders, limited companies, and the strengths and weaknesses of each.
Understanding Sole Traders
A sole trader (also called a sole proprietorship) is the simplest business structure. As of 2024, there were some 3.1 million sole traders in the UK.
As a sole trader, you’re classified as self-employed and run your business as an individual. You have complete control over your business decisions and keep all the profits after tax.
Setting Up as a Sole Trader
Setting up as a sole trader is relatively straightforward.
You need to register with HMRC for self-assessment and start keeping records of your income and expenses.
The costs involved in setting up and running a sole trader business are minimal compared to a limited company.
Advantages of Being a Sole Trader
One of the main advantages of being a sole trader is flexibility combined with simplicity. You have complete control over your business decisions and can adapt quickly to changes in the market or your personal circumstances.
Additionally, sole traders have more privacy than limited companies, as you don’t have to make your accounts public or have your details available on the Companies House register.
This is useful for building a young business and trying out different ideas/products/strategies, etc., without attracting potential competitors’ attention.
Disadvantages of Being a Sole Trader
Of course, there are some disadvantages to being a sole trader.
Firstly and most importantly, you have unlimited liability for your business debts and obligations. So, if your business fails, your assets, such as your home or car, could be at risk.
Suppose you need a loan to invest in your business. This loan will be in your name, meaning it’s your responsibility if your business fails and you can’t pay it. The same goes for lawsuits.
Say someone sues you for damages – if your insurance doesn’t cover it (unless you have personal indemnity insurance (PII)), your assets are at risk.
Furthermore, some customers and suppliers may perceive sole traders as less credible or professional than limited companies.
This can make it harder to win contracts or negotiate better terms. Companies might prefer – or even require – working with limited companies rather than sole traders.
Understanding Limited Companies
A limited company is a separate legal entity from its owners (shareholders) and managers (directors). This means the company can enter into contracts, own assets, and be sued in its own right.
Benefits of Limited Liability
One of a limited company’s main benefits is its limited liability protection.
If the company fails, the shareholders are only liable for the amount they have invested in the company, and their personal assets are protected.
This is a massive advantage if your business involves high risks or potential liabilities.
Tax Efficiency and Professional Image
Limited companies can also be more tax-efficient than sole traders, though it’s difficult to say which is the most tax-efficient.
Directors can also combine salary and dividends to minimise their personal tax liability. As your business grows and your profits increase, the tax advantages of a limited company often become more evident.
If you want to maximise your tax position as a company director, Double Point can help.
Another leading advantage of a limited company is the professional image it can provide.
Limited companies are often perceived as more credible and professional than sole traders, which can help when bidding for contracts or seeking investment.
Finally, limited companies grant continuity, as the company can continue to exist even if the ownership changes, making it easier to sell the business or pass it on to the next generation.
Responsibilities and Costs
Operating as a limited company also has some disadvantages. First, limited companies have broader, more complex legal and administrative responsibilities than sole traders.
You must register your company with Companies House, file annual accounts and confirmation statements, and maintain statutory registers. This can be time-consuming and may require the help of an accountant or legal professional.
Setting up and running a limited company is also more expensive than being a sole trader. There are incorporation fees, annual filing fees, and the cost of preparing and auditing accounts (if required).
Limited companies also have less privacy than sole traders, as you must file your accounts and other information with Companies House, which is available to the public.
Lastly, as a limited company director, you also have legal duties and responsibilities, such as acting in the company’s best interests and keeping proper records.
Failing to meet these duties can result in fines, disqualification, or even prosecution.
Sole Trader Versus Limited Company Comparison Table
Here’s a quick side-by-side comparison of sole traders vs limited companies:
| Criteria | Sole Trader | Limited Company |
| Tax Efficiency | Subject to personal income tax rates | Corporation tax with dividends taxed separately, more options for tax planning |
| Liability | Unlimited personal liability (personal assets at risk) | Limited liability – personal assets protected |
| Administrative Burden | Simple bookkeeping and reporting | More complex – annual accounts, corporation tax returns, company filings |
| Professional Image | Less formal, suited to small businesses | More credible and professional image, often preferred by clients |
| Profit Reinvestment | Fewer tax-efficient options for reinvestment | Can reinvest profits more tax-efficiently (e.g. through pensions, dividends) |
| Pension Contributions | Limited to personal contributions | Can make employer contributions, which are tax-deductible |
| Ownership and Control | Complete control and ownership | Ownership can be shared with shareholders, but decision-making may involve others |
| Raising Capital | Limited options, usually personal savings or loans | Easier to raise capital by issuing shares |
| Selling the Business | More complex to sell as an individual | Easier to transfer ownership by selling shares |
Key Factors to Consider When Making The Choice
Now, let’s consider a logical workflow to consider in detail whether you should operate as a sole trader or limited company, or indeed, make the transition from sole trader to limited company:
Assess Your Personal Liability Risk
First, consider the level of personal liability risk your business faces.
Suppose your business involves high-risk activities, such as providing professional advice or working on construction sites. In that case, you may want to consider a limited company structure for the added personal liability protection it offers.
For example, suppose you’re a self-employed consultant offering financial advice.
If a client suffers losses due to your advice and successfully sues your business, a limited company structure could protect your personal assets from being seized to pay the damages.
Insurance can also protect you in this situation, but acting as a limited company provides another layer of inherent protection.
Evaluate Your Expected Profits and Tax Implications
Next, consider your expected profits and the potential tax implications of each structure.
- Sole traders pay income tax and National Insurance contributions (NICs) on their profits, with tax rates increasing as profits grow.
- Limited companies pay Corporation Tax on their profits, which is currently lower than the higher income tax rates.
- Company directors can also take a combination of salary and dividends, which can be more tax-efficient. Dividends are taxed at lower rates than salary and don’t incur NICs.
Comparing tax and earnings for sole traders and company directors.
Looking solely at tax, in most cases, if your business has low profits (e.g., under £30,000 per year), the tax savings from a limited company structure may be minimal and not worth the added administrative burden and costs.
It’s often said that drawing a salary from a limited company becomes more tax-efficient at higher incomes over £100,000, which you can see below (taking a small salary and the remainder as dividends).
Consider Your Industry Norms and Client Expectations
Also, think about the norms and expectations in your industry.
- In some sectors, such as IT, consulting, or professional services, clients may prefer to work with limited companies, perceiving them as more credible and professional.
- In other industries, like creative services or trades, sole traders are more common and may not face the same expectations.
Future Plans
Finally, consider your long-term goals and exit strategy. This is the dealbreaker in many cases.
- A limited company structure may be more suitable if you plan to grow your business, attract investors, or expand internationally. It allows for the issuance of shares and provides a clear ownership structure.
- If you eventually want to sell your business, a limited company can offer a smoother transfer of ownership through the sale of shares, while selling a sole trader business may involve a more complex transfer of assets, contracts, and liabilities.
It’s pretty simple: If you want to truly build a business – rather than a personal venture – you’ll eventually need to incorporate or choose another business structure like a limited liability partnership (LLP).
Consider Seeking Professional Advice
Choosing the right business structure is a fundamental decision that can have long-term implications for your business and personal life.
While this guide provides an overview of the key differences between sole traders and limited companies, seeking professional, personal advice for your specific circumstances is essential.
At Double Point, our experienced team of chartered accountants can provide expert guidance on choosing the right structure for your business.
We can help you weigh the pros and cons of each option, considering factors such as tax efficiency, personal liability, credibility, complexity, and future plans.
Once you’ve chosen your structure, we can assist with the registration and setup process, ensuring you comply with all legal and tax requirements.
Contact us now to kickstart your business journey!
