One of the first questions raised for an English entrepreneur is whether they should trade as a sole trader or a limited company.
Anyone of you that has already researched this topic will find many conflicting sources of advice. Or even the unwanted answer of: it depends.
Well it does depend but that shouldn’t be the dismissive answer that it seems. Whilst it does depend, there are very specific circumstances and business types that are more black and white.
In this article we discuss the finer details of what exactly each option is. We also look at the benefits of being a sole trader versus a limited company and vice-versa.
What is a Sole Trader?
A sole trader is any person in the UK who owns or operates their own small business acting as an individual.
What this means is essentially the owner of the company and the company itself are legally the same thing.
All profits, losses and taxes for the company are profits, losses and taxes for the owner of the company. That is to say that if the company earned £100 in profit then that profit would be in the company owners personal bank account and be taxed as such.
As a knock on effect of this all debts to suppliers or legal settlements (unless insured) are personally secured against the company owner and more importantly the company owner’s personal assets.
All income tax filings for the company are filed through the owner as a self assessment form to HM Revenue and Customs (HMRC). This can be completed online and is free of charge.
What are the advantages of being a Sole Trader?
As you may have guessed from what is a sole trader above, the advantages of being a sole trader tend to be around it’s simplicity.
With the lack of separation between the company and the company owner it makes financials extremely streamlined and simple.
Since the company’s finances are identical to the owner’s financials, calculating things such as wages, profit and taxable deductibles are done as a whole and not individually.
It is so streamlined that the vast majority of sole traders file their own taxes as opposed to hiring an accountant which would be advisable as a Limited Company.
Another advantage to being a sole trader is the traditional view of being your own boss. As a sole trading company owner you literally are in 100% control of the company and everything surrounding the company.
You do not need to consider shareholders or company directors as a sole trader and every decision starts and ends with you.
This alone can be a key driving factor for many starting a company in the UK.
The other main advantage stems on from being your own boss outlined above.
The fact that the company structure is so streamlined in the sense that all decisions can come from you with no extra consideration, makes your company extremely reactive to situations
By reactive we mean that you can adapt and change with incredible speed compared to a structured Limited Company.
Imagine you find a new product or service you wish to offer – you can literally start on the same day provided you can fulfil that commitment. Even if you wanted to drastically change pricing structure or marketing strategy, when and how can be decided here and now.
This in comparison to a structured company who must seek sales, marketing or operations approval from the relevant directors and then pass the change to the shareholders. Discussions can draw on for weeks or months which may see the opportunity pass.
What are the disadvantages of being a Sole Trader?
While the advantages of being a sole trader are mainly in it’s flexibility, it’s disadvantages come in it’s lack of structure.
With all the finances being the equivalent of the company operators finances as outlined above brings more risk. This risk comes in the form of legal proceedings or debts.
Should your company run up any debts that go unpaid, suppliers are likely to chase you and your personal assets.
Whilst legal proceedings should be minimal and debts relating to the company also at a minimum, it is very important that you clearly understand this. There has been many entrepreneurs who have been bankrupted through legal costs related to negligence of their employee or themselves.
There are insurance policies that can cover these legal proceedings but when it comes to debts you are unfortunately on your own. If you company goes out of business with debts on it’s books then you will personally have to pay them.
The other main disadvantage of being a sole trader comes down to legitimacy.
Many suppliers and even some customers will not deal with a sole trader. They require VAT or company registration numbers which generally only come as part of being a limited company.
These situations tend to be on larger contracts specifically as a business to business venture.
Tradesmen or alike will also sometimes see this as a issue but far less so than most other industries. B2C (business to customer) ventures as a whole may in a lot of cases be OK with legitimacy related issues.
How do I become a Sole Trader?
Becoming a sole trader is very easy.
If you have earned over £1000 (correct for 2020) in the current financial tax year then you qualify to become a sole trader.
Simply go to the HMRC government website here and fill out the online form for self assessment.
Once completed and approved you will be required to fill out a self assessment form once a year to declare your turnover, gross profit and losses for your tax return.
What is a Limited Company?
A limited company is a company that is it’s own legal identity. It’s owners and managers are not personally liable and the company as a whole is an individual entity.
This individual identity established by the company means that all profits and losses occurred by the company belong to the company. Money cannot be freely moved in and out of company accounts and debts or legal proceedings lay solely at the company’s liability.
Tax returns, company wages and shareholder payouts are all tightly managed and accompanying paperwork is almost always required.
What are the advantages of being a Limited Company?
The undeniably best advantage of being a limited company is the limited liability that comes with the business structure.
Legal proceedings by disgruntled customers and debts incurred with suppliers happen more often than desired. Being able to make these business decisions without the threat of personal assets being at stake is fundamental in UK business.
This isn’t to say that the company operators are completely free to do what they want. There are many guidelines and regulations that still must be followed rigorously. It does though allow the business to operate and grow at will.
Another advantage comes as a double edged sword, tax.
If you are earning enough then a limited company offers a far better tax structure than a sole trader. Since all money coming into the company is owned by the company, corporation tax is implemented instead of income tax.
In 2020 corporation tax is set at 18% whereas income tax starts at 20% rising to 45% depending on earnings. This can equate to tens of thousands in a difference in certain circumstances.
And the final advantage worth noting is credibility.
As mentioned above in the disadvantages of being a sole trader, some suppliers and customers will only deal with a limited company. This can be for a variety of reasons but being a limited company does gain credibility in these instances.
What are the disadvantages of being a Limited Company?
Choosing to operate your UK company as a limited company comes with additional responsibilities and requirements.
Unlike a sole trader where you and the company are the same, a limited company requires it’s own documentation, tax returns and accounting records.
This is all on top of your own personal tax returns as an owner or employee of the limited company.
Needless to say this can equate to a lot of paperwork and not every entrepreneur is an accomplished accountant.
In most situations an accountant employed to cover the company financials is a must and just an extra cost to doing business.
Another disadvantage comes at a cost of this detailed information required by every limited company.
Companies House lists all UK registered limited companies as public information. This public information includes financial details relating to any company.
This can mean competitors or customers regularly researching your company and it’s profits/losses. Whilst many may not have much to hide, anyone that does will soon be found out via a simple search of the company name.
How do I start a Limited Company?
Setting up a limited company is a lot more complex than setting up as a sole trader.
After choosing that a limited company is the right move for you and your company you will need to head on over to the UK government website and double check the criteria for registering.
These criteria are listed in order on the link above and include things like choosing company directors, a company name and what documents your company will keep.
It is advisable you speak with an accountant before committing to this decision in most circumstances.
Conclusion
The general rule of thumb is that if your company is earning under £60,000 per year then staying as a sole trader is probably the most prudent route for you.
It isn’t until you go over the £60,000 threshold that tax benefits of being a limited company will really come into play.
With that being said it is really dependant on you, your company and what industry your company operates in.
In either eventuality speaking to a qualified accountant is probably the best thing you can do before making any rash decisions you may regret down the road.
