One of the first decisions you will need to make as a new business owner is deciding whether to run your business as a sole trader or as a limited company.
If you’re new to the business world, it may be difficult to understand what exactly the difference is between the two.
This article explains the key differences between the two business structures and outlines which is the better option for you depending on your business and its current stature.
What is a sole trader?
Operating as a sole trader is the most common structure for entrepreneurs who are just starting out. If you are a sole trader, it means your business does not have a legal identity separate from yourself and is not recognised as a standalone company.
As you are the sole person who owns and controls the business, the law recognises the business and yourself as the same entity, which could make you personally liable for any losses and debts that your business may incur.
What are the advantages of being a sole trader?
- Being a sole trader is relatively easy to set up in comparison to incorporating a company
- Sole traders have more straightforward accounting and end-of-year tax duties
- There are fewer compliance requirements and checks
- You have total authority and control over the business’ operations
- As the sole owner, you can keep all of your business’ profits
What are the disadvantages of being a sole trader?
- Your business’ debts and losses can become your personal debt
- Sole traders pay a higher rate of tax in comparison to limited companies
- You are less likely to secure significant third-party funding
- Unsuitable for large-scale operations due to its simplicity
What is a limited company?
If you opt to incorporate your business, it means you will set your company up as a limited company, which will have its own separate legal identity, ensuring your business’ finances don’t affect your own finances.
As a limited company director, you have limited liability on any losses or debts incurred by the business. Any profits earned are owned by the company and paid out among shareholders.
Limited companies in the UK are registered at Companies House and are owned by shareholders and run by directors. There may be several shareholders, or just yourself.
What are the advantages of operating as a limited company?
- You have limited liability should your business incur losses or debt; leaving your personal finances unaffected
- Limited company directors can receive remuneration via a combination of salary and dividends, therefore paying a lower overall rate of tax
- You may offer shares in your business to raise investment
- It is easier to secure significant funding as a limited company in comparison to as a sole trader
- Exiting a limited company is a more straightforward process in contrast to other structures
What are the disadvantages of operating as a limited company?
- Setting up and maintaining a limited company can be complicated and time-consuming as opposed to operating as a sole trader
- Limited companies are subject to more regulation and compliance scrutiny
- Accounting/taxation duties can be challenging and costly to keep up
- There may be less control over the business if there is more than one director
What is the difference between a sole trader and a limited company?
The most significant difference between operating as a sole trader or as a limited company is that as a sole trader, one person owns and controls the whole of the business, but they expose themselves to personal liability, whereas a limited company involves less personal risk as shareholders have limited liability for the business.
There are several tax considerations to bear in mind when deciding which is the better option for you and your business. Read our previously published article for more.
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