Understanding Sole Trader vs Limited Company: Know Which One is Best for You

Many small businesses in the UK at some point or the other will have to decide whether to trade through their own limited company or remain a sole trader. Before you can determine which option might be ideal for you, you’ll have to know what they both entail.

Who is a sole trader?

This structure is the simplest any business can go for and in fact is ideal for many businesses that are just starting out. As a sole trader, you’re self-employed and are the only owner of your business. It’s relatively easy to register yourself as a sole trader, which is something you need to do for tax purposes.

Should you remain a sole trader?

As a sole trader, you won’t have to make your details public and the only major paperwork you’ll have to do is an annual self-assessment tax return. Also, you’ll be able to offset any losses against other income you make in the year. Sole traders are not subject to the restrictions and laws imposed on business owners by The Companies Act.

While sole trader status undoubtedly gives you more freedom, you have to consider that you could end up losing your possessions, including your house, if you need to pay creditors. This is because the UK law does not recognise the sole trader as being a separate entity from their business. You may also find it difficult to raise money because banks and investors are likely to consider you a risk.

Sole traders are required to pay Classes 2 and 4 National Insurance and higher rates of tax at certain levels of earnings. If you make above £45,000, you’ll have to pay 40% on income and if your income exceeds £150,000, you’ll have to pay 45%.

What is a limited company?

A business that’s registered as a limited company is a separate legal entity with a director who is responsible for the decision-making of the company, including its financial and legal decisions. It can be a one-person business, but your personal finances will be entirely separate from that of the company. You’ll be a shareholder and can be paid dividends and/or a salary from the business’s profits.

Would you be better off going limited?

If your company is limited, you won’t have your personal assets liquidated along with the company’s if there are financial problems. You’ll also have the potential to be more profitable since all the business’s earnings wouldn’t be taken as income for taxation and other purposes.

It can be easier to obtain the financing you need to run your business since your personal credit rating will have nothing to do with the vetting process. Also, limited companies have better credibility and improved reputation. The problem with a limited company is the added responsibilities. There’s a ton of paperwork involved, as well as extra costs and it can be time-consuming.

Be sure to take your time to decide what’s best for you. Every company will have its own separate needs that will different as you navigate those first few years, so it’s important to lock yourself into the right set-up for trade. Making the wrong call due to a lack of your own research could expose you to higher levels of risk further down the line.