Sole trader vs limited company – Which is better?

The primary difference between a sole trader and a limited company lies in their legal structures. For sole traders, there’s no separation between the individual and their business. Unlike limited companies, sole traders can be held directly accountable for all business liabilities. When deciding to set up a limited company, it’s essential to understand this distinction, as it significantly impacts the responsibilities and risks involved.

Read on if you’re wondering what the differences between a sole trader and a limited company are and the advantages and disadvantages of both business structures.

What is a sole trader?

As a sole trader, you operate as a self-employed business owner with no legal distinction between you and your business. This implies that while you retain all profits, you also bear all responsibilities.

Setting up as a sole trader is straightforward. It involves registering with HMRC for a self-assessment tax return, leading to income tax and national insurance contributions at the end of each tax year.

The advantages of being a sole trader

Less administrative hassle: An annual self-assessment tax return is required; no account filing is necessary.

Saves money: It’s cheaper to start up as a sole trader, as a limited company is required to register with Companies House.

Privacy is maintained: Unlike limited companies, sole traders are not obligated to disclose specific information on public registers at Companies House.

Full entitlement to post-tax profits.

The disadvantages of being a sole trader

Personal liability for losses: As a sole trader, any business losses are your responsibility. However, insurance may mitigate some risks.

Dependence on personal credit: Your personal credit rating determines the funding opportunities for your business, potentially limiting your options.

What is a limited company?

A limited company operates as a distinct legal entity, separate from you. As a shareholder, you may share ownership with others and also function as a director, managing the day-to-day operations.

Setting up a limited company is relatively simple and cost-effective. However, when doing so, there are certain aspects to consider and document in your articles of association, particularly concerning directors or shareholders. Don’t worry if you don’t know what these are, that’s the solicitor’s job.

Advantages of a limited company

Professional status: Your professional status and image will improve when you start trading as a limited company.

Employee benefits: Employees have the opportunity to be granted shares via a company share scheme; boosting employee motivation and loyalty.

Limited personal liability: As a separate entity, the company shields your personal assets from creditors in case of financial difficulties.

More deductible business expenses: Claiming more business expenses than a sole trader is possible, reducing your taxable profits.

Enhanced credit potential: A separate business credit rating can improve borrowing capabilities.

Credibility: Larger companies often prefer dealing with limited companies.

Disadvantages of a limited company

Greater administrative responsibilities: Year-end company accounts submission is mandatory; as well as keeping documents up-to-date like statutory books.

Public transparency: Companies must disclose certain information, like director names, to Companies House, which is publicly accessible.