The difference between a sole trader and limited company
Key Takeaways
If you’re starting a business, you’ll need to choose whether to do so as a sole trader or limited company
Each has its own set of advantages and disadvantages, which can significantly impact your business' operations, finances, and liability
It’s simple to set up as a sole trader, whereas limited companies have more complex structures and require more paperwork
What are the key difference between sole traders and limited companies?
When starting your own business, one of the first decisions you'll need to make is the legal structure. Two common options are sole trader and limited company. Each has its own set of advantages and disadvantages, which can significantly impact your business's operations, finances, and liability.
A sole trader is a simple business structure where you, as the individual, are personally liable for all business debts and obligations. This means your personal assets, such as your home or savings, could be at risk if your business fails.
On the other hand, a limited company is a separate legal entity. This means that the company itself is liable for its debts, protecting your personal assets. While limited companies offer greater protection, they also come with more complex administrative requirements, such as registering with Companies House and filing annual accounts and tax returns.
These tables shows some of the key differences between sole traders and limited companies:
Advantages of being a sole trader | Disadvantages of being a sole trader |
|---|---|
Simplicity: Setting up a sole trader business is relatively straightforward, involving minimal paperwork and legal formalities. | Liability: As a sole trader, you have unlimited liability for all your business debts. This means your personal assets, such as your home or savings, could be at risk. |
Flexibility: You have complete control over your business decisions and operations. | Growth: Raising capital can be challenging, as banks may be hesitant to lend to sole traders. |
Tax efficiency: Sole traders often benefit from simpler tax returns. They complete a self-assessment tax return at the end of the financial year, and pay income tax and National Insurance accordingly. | Lack of business continuity: If you become ill or unable to work, your business may suffer. |
Privacy: There’s no obligation to make your accounts public. |
Advantages of a limited company | Disadvantages of a limited company |
|---|---|
Limited liability: As the director of a limited company, personal assets are generally protected from business debts. | Increased complexity: Setting up and running a limited company involves more paperwork, legal formalities, and administrative costs. |
Enhanced credibility: Limited companies are often perceived as more professional and reputable. | Higher costs: You'll need to file annual accounts and tax returns, and pay corporation tax. |
Tax benefits: Corporation tax rates can be lower than income tax rates, especially for small companies. | Loss of control: While you have control over your business, you must follow certain legal procedures and corporate governance rules. |
Easier access to finance: Banks and investors may be more willing to lend to limited companies. | Lack of privacy: Limited companies are obligated to disclose their turnover and profit figures to Companies House. This information is made publicly available, meaning anyone can view your financial records. |
More deductible business expenses: As a limited company, you’ll be able to expense a wider range of business costs, lowering your tax bill. |
How to decide between a sole trader and a limited company
Deciding between a sole trader and a limited company depends on various factors, including your business goals, financial situation, and risk tolerance. If you're concerned about personal liability, a limited company offers better protection. However, it requires more paperwork and administrative overhead.
Tax implications also differ between the two structures, so consulting with an accountant is crucial. If you foresee significant growth and potential investment, a limited company can be more attractive.
The best choice depends on your specific circumstances. Consider your comfort level with administrative tasks, financial risks, and long-term business goals. Consulting with a professional advisor can help you make an informed decision.
Do I need business insurance as a sole trader or limited company?
Whether or not you need business insurance is always a personal decision, based on the nature of your work and the level of protection you need. However, business insurance can give you peace of mind as a small business owner, and may be a legal requirement under certain circumstances — for example, if you employ other people as part of a limited company.
You can check if business insurance is right for you and get quotes through MoneySuperMarket’s comparison tool.
There’s no right answer to whether it’s better to be a sole trader or limited company, and this will depend on your specific business activities, needs, and finances. Sole trader status is simpler, and offers a level of privacy that you don’t get with a limited company. Limited companies offer liability protection and potential tax advantages.
In some cases registering as a limited company can mean that you pay less tax and National Insurance contributions to HMRC. This is because most limited company owners pay themselves both a salary and a dividend from the company’s earnings. Many people take a lower salary to decrease their PAYE tax liability, and make up the extra with dividend income (which is not liable to National Insurance contributions if below a certain allowance).
However, you’ll likely need an accountant to operate as a limited company, and the costs of setting yourself up and hiring extra help can negate any tax benefits.
Sole traders have unlimited personal liability for business debts. This means that if your business gets into debt, you’ll be responsible for paying it off, and your savings, investments, or even your home could be taken to settle them.
To set up a limited company you’ll need to choose a company name, name a company director and secretary, identify people with significant control over your company, set up a business bank account, and register with Companies House. You’ll also need to prepare documents agreeing how to run the company, such as a memorandum of association and a statement of capital. You can go to gov.uk to find a guide to setting up a limited company.
Setting up a limited company can be complex, so most people hire an accountant to help guide them through the process and assist with bookkeeping.
Someone operating as a sole trader — such as a freelancer — can choose to register and operate as a limited company. You can also simultaneously operate as both a sole trader and a limited company if your business has different arms and you wish to process their finances separately, however this will mean lots of paperwork and at least two tax returns.
No, sole traders don’t have to register with Companies House. Some people see this as an advantage of being a sole trader, as Companies House requires you to make your company accounts public.
