The difference between a sole trader and a limited company

Choosing a legal structure for your new business depends on the nature of your company. There are also pros and cons to both incorporating as a limited business and working as a sole trader.

In 2020, around 3.5 million UK businesses were trading as sole proprietors, compared to approximately 2 million active limited companies.

Here we’ll explain the difference between a sole trader and a limited company to help you make informed judgments about getting started with your new business concept.

How to choose a trading structure for a UK business

Every company needs to have a legal structure, which could be:

  • A limited company, registered with Companies House
  • A partnership, with a formal partnership agreement
  • A sole trader – in essence the same as being self-employed

What is a limited company?

Incorporating a business means that your company has a separate legal structure from you as an individual.

Your limited company is an entity in its own right, with its finances kept separate from your personal affairs.

The company owners are the shareholders, and the managers are the directors, all of whom must be registered with Companies House.

How is a sole trader different from an incorporated company?

Many small businesses begin life as a sole proprietorship, which is generally the most straightforward option as it doesn’t require much work to set up.

Essentially, a sole trader is someone self-employed; who is the only owner of their business.

Given the simplicity of this structure, it’s easy to see why it’s the most popular way to run a business.

However, you will still need to register as a self-employed sole trader with HMRC and submit your tax returns!

Sole trader vs limited company

There isn’t a catchall answer to deciding on the right way to set up your business, and there are several factors to consider.

Let’s run through some of the advantages and disadvantages to help clarify where the pinch points lie.

Advantages of incorporating as a limited company

Some aspects of business are undoubtedly a little easier if you’re an officially registered company.

For example, buying a property through a limited company is usually more straightforward than proving your average income to apply for a sole trader mortgage.

Other benefits include:

  • Legal separation from the business – your liability for company debts is limited, so your personal assets won’t be at risk if the business fails (personal guarantees notwithstanding).
  • Registering a company name protects it, so competitors cannot incorporate a business with the same name.
  • Limited companies benefit from tax efficiencies since corporation tax rates tend to be lower than income tax.

You’ll also find wider tax allowances for limited businesses, so you might make a higher profit by taking advantage of tax deductibles.

Disadvantages of trading as a limited company

On the flip side, registering a new limited business does mean more paperwork and ongoing compliance requirements.

Limited businesses are obliged to file annual accounts, of which some information is readily available in the public domain.

Therefore, you have less privacy than a sole trader who doesn’t have to disclose their financial affairs in the same way.

Advantages of a sole trader business status

Setting up a new company as a sole trader is the faster option, with little paperwork aside from verifying your tax position with HMRC.

Owners aren’t bound by the fiduciary responsibilities of a limited company director, and therefore sole trader businesses typically cost less from an admin perspective.

Disadvantages of a sole trader business status

  • Sole traders are regarded as the same as their business, so legally, you are responsible for all the company’s debt.
  • Expansion opportunities can be limited since a sole proprietor business doesn’t always have a company’s credibility with public accounts filed on Companies House.
  • Depending on your turnover, it isn’t always beneficial to remain a sole trader – many businesses decide to incorporate once they reach a certain earnings level.

Choosing between a limited company or a sole trader

Ultimately, the choice of business structure is yours, and it’s wise to seek professional advice about tax efficiencies and risk before making any long-term decisions.

Other factors include insurance costs and any client requirements – some sectors are far easier to break into if you have an official company registration number.

Get in touch with the Harper James Solicitors team for further information from their startup lawyers in the UK about the pros and cons of each trading style and independent advice about which option is optimal for you!


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