Should I register my business as a sole trader or limited company?

This in one of the first hurdles you will encounter when you decide to start your own business – whether to set up as a sole trader through HMRC, or incorporate a private limited company through Companies House. Both legal structures are great options for most small businesses and first-time entrepreneurs, but incorporation tends to be more beneficial if your annual taxable income (i.e. net profit) is likely to reach or exceed £25,000. At this point, it’s usually more tax-efficient to operate as a company, and it’s a more appealing and credible legal structure to potential lenders, investors and larger clients.

We’ll take a detailed look at the pros and cons of both structures. This should give you a better idea of the most suitable one for your new business and allow you to make an informed decision.

Sole Trader

A sole trader is the term for someone who is self employed. To set up as a sole trader, you have to register your business with HMRC and sign up for Self-Assessment. You are responsible for competing your own tax return and paying Income Tax and National Insurance Contributions through Self-Assessment each year. Business-related expenses are tax-deductible, and you can employ people to work for you. However, you are personally responsible for all business debts and liabilities because you (the sole trader) are the business.

PROS  

• Register online in minutes.
• No set-up cost.
• Can begin trading prior to registration.
• Simple record-keeping requirements.
• Minimal reporting requirements.
• Sole trader details are not available to the public.
• Profits can be removed at any time.

CONS

• No legal or financial distinction between the sole trader and their business.
• Unlimited liability for debts – personal assets are at risk.
• Income Tax and National Insurance liability on all profits.
• Business name is not automatically protected.
• Can be challenging to obtain finance, investment and high-value contracts.
• Difficult to compete against incorporated businesses when bidding for contracts.
• Not tax-efficient for higher tax-rate payers.
• Can stop being a sole trader at any time. No fee to pay.

Limited Company

A limited company is classed as an individual ‘person’ in the eyes of the law. When you incorporate a limited company through Companies House (the official UK registrar), your business becomes a distinct legal entity with full liability for its own debts. You are not your company – you are simply the owner and director of the company. This means you have limited liability for company debts, so your personal assets are protected.

There are two types of private limited companies – limited by shares and limited by guarantee. Limited by shares companies are owned by one or more shareholders. Limited by guarantee companies are owned by one or more guarantors. Both types of companies are managed by one or more directors. The liability of company owners is limited to the value of their shares or guarantees.

PROS 

• Company is responsible for its own debts; owners benefit from reduced financial liability.
• Increased trust and credibility because the public has access to company information.
• Better chance of obtaining high-value contracts.
• Can be owned and managed by one person or many people
• Company can exist beyond the involvement of original owner(s)
• Name of the business is protected after company formation
• Suitable for commercial businesses (limited by shares) and non-profit organisations and charities (limited by guarantee).
• Limited companies gives the impression of a business that is large and established.

CONS

• Have to pay an incorporation fee to register a company.
• Detailed application form must be completed for Companies House.
• Business and personal details are disclosed on public record.
• Complex accounting requirements.
• More reporting, filing and record-keeping obligations than sole traders.
• Must have a registered office.
• Income belongs to the company in the first instance. To remove money for personal use, you must take it as a director’s salary, dividend, director’s loan or expenses.
• Costs money to close a company.

For many people, the decision is clear cut. However, if you’re still in any doubt, please consult an accountant or professional business advisor for expert help and guidance. Don’t rush into making a decision if you’re unsure. You can find free, local support and advice for your startup from Business Gateway (Scotland), Growth Hubs (England), NI Business Info (Northern Ireland) or Business Wales.