Sole Trader vs Limited Company - Which one is for you?

It is imperative for a business owner to understand the difference between a sole trader and a limited company. In this article, we will guide you through both of these legal structures, providing insights into their respective pros and cons. By the end, you will be well-equipped to make an informed decision as to which structure is best for you.

Sole Trader or Limited Company - What is the difference?

A sole trader is an individual who owns their entire business fully. The business owner and the business are one legal entity - there is no distinction. The sole trader will be personally held liable if the business was to fall into debt.

A limited company, on the other hand, is a business which is legally separated from its owner. The business owner has his own legal entity whilst the business holds a separate identity.

Sole Trader - The Advantages & Disadvantages

A “sole trader” is the most popular legal form of business. In 2022, 56% of the private sector in the UK comprised of sole proprietors. Before commencing your business journey, it is important to weigh out the advantages and drawbacks of a sole trader.

Sole Trader- The Advantages

1. You will be your own “boss”
A sole trader is an individual who fully owns their business. In this legal structure, there is no distinction between the business owner and the business itself – they are considered a single identity. As a sole trader, you will have full operational flexibility to run the business as you wish. Having operation flexibility means that swift adjustments can be made in accordance with changing trends. You would be able to change prices and adjust stock as you see fit. This could prove advantageous in an ever-competitive and fast-changing market.

2. Set up is a breeze
Setting up a sole trader is quite straightforward and does not require much effort. To get started, you simply need to register with HMRC, and this process is free. Unlike a Limited company, there is no requirement to register with Companies House. Therefore, in comparison to a limited company, a sole trader can get started fairly quickly.

3. Privacy 
Financial accounts of a sole trader remain private along with their personal information. This is good because your competitors will not have access to your business progress. They will not be able to see how you are coping nor will they be able to identify your success.

4. Retention of Profits
As a sole trader, you are not required to share your profits with shareholders. This means you have the flexibility to retain the profit for personal use or reinvest it back into the business. Most sole traders do not have employees which further helps the business to keep costs down.

5. The accounting process is simpler
Unlike a limited company, sole traders are not required to do Annual Accounts or Corporation Tax Return. You will be obliged to submit a personal Self-Assessment Tax Return. But in comparison to a limited company, the process is much simpler.

6. Changing your mind is easier
Many entrepreneurs start their business journey as sole traders. This option allows them to test the waters and build their confidence. The flexibility of being a sole trader gives them the ability to gradually adjust their existing life to the new one of being a business owner.

As a sole trader, you can always transition to a limited company later if you wish. However, if you were to start off as a limited company and later decide to become a sole trader, the process would involve a more formal and complex procedure.

Sole Trader - The Disadvantages

1. Unlimited liability
As mentioned before, as a sole trader, the business and the owner become one legal identity. This means that the liabilities of the business are the liabilities of the business owner. For whatever reason, should the business fall into debt, the money owed can be seized from your personal assets. This means that the owner’s valuable possessions, car, and even home are at risk.

2. Limited capacity to raise funds
Often, banks prefer the accounting transparency that comes with a limited company over the more concealed nature of sole traders. Consequently, lenders may be more hesitant to provide substantial amounts of funding to sole traders.

3. All the important decisions lie with you
Being a sole trader can get lonely because the onus is fully you. On one hand, you have full control of the business reins but on the other, you do not have anyone to discuss the important decisions with. This success and the failure of the business lies solely on your shoulders.

4. Not as attractive to customers
From a customer perspective, there is a perceived lack of prestige for sole traders in comparison to limited companies. Many customers view sole traders as “less professional” than a limited company. In many cases, this perception is completely untrue but the general public opinion is that a limited company has more credibility than a sole trader.

Limited Company - The Advantages and Disadvantages

Limited Company - Advantages

1. Personal assets are protected
As explained before, the business owner and business are two separate legal identities which means that your personal assets are protected should the business fall into debt.

2. Professional Image
Those who have a limited company enjoy a more prestigious image in comparison to a sole trader. This is due to the fact that the structure of a limited company indicates to the customers a certain level of trust and professionalism.

3. Tax efficiency
If proper tax planning takes place, then a limited company will be able to find opportunities to save on tax. A good accountant may be able to find you tax deductions or allowances which cannot be found with a sole trader.

4. Company name is protected
The business names of limited companies are all registered on Companies House. No one will be able to use the same name as you. If they were to try, this would simply be impossible because Companies House would not allow it, they would have to choose another name. However, the business name of a sole trader can be taken with very little consequence.

Limited Company - The Disadvantages

1. Expensive set up
Forming a limited company comes with additional legal and accountant fees in comparison to a sole proprietor. However, these fees may be seen as an initial investment because the tax advantages that come with being a limited company often make up for the initial costs.

2. Lack of privacy
When a company is registered on Companies House, the personal information of the stakeholder as well as financial records will be available publicly. Information such as your name, date of birth, and even your address can be accessed by anyone.

It is for this reason that one should strongly consider getting a business address that is different from their home address. Often, business owners can conduct trading from the comfort of their homes so they do not require a physical business address. Virtual offices provide a cheap alternative to those companies who need a professional business address but do not require physical space. To find out more, click here.

3. Structural company change is lengthy
A limited company will find it much harder to change their company structure from a limited company to a sole trader. There will be additional legal and administrative responsibilities involved. The plus side is that most business owners do not need to worry about this because structural change usually only takes place when the business owners wish to become more tax-efficient.

4. Additional responsibility
Directors of limited companies are required to report specific documents to HMRC and Companies House. One example is the “Confirmation Statement,” an annual submission that notifies relevant bodies of any alterations to your limited company such as the registered office address, directors, shares, and shareholders.

In summary, there are various advantages and disadvantages to operating as a sole trader or a limited company. The decision you take will depend heavily on the nature of your business.

Generally speaking, sole trading offers privacy, freedom, and an opportunity for one to test out the waters of a new business venture. On the other hand, a limited company owner enjoys a more prestigious image, tax-saving opportunities, and protection of personal assets.