Sole Trader Vs. Limited Company: What are the Key Differences?
The business structure you choose to start a business weighs in a lot on liability, profitability, tax implication and growth.
So, how do you determine what’s the right fit for you?
For this reason, choosing a business structure is one of the biggest decisions an entrepreneur has to make. You can decide to go it alone as a Sole Trader or form a Limited Company where you have any number of employees.
Regardless of the structure you decide to trade with, it’s crucial to UNDERSTAND each deeply, as each has some benefits and drawbacks. Incorpuk can help you with the best advice on business structure in the UK and also help you form your company today.
In this post, we’ll dig deeper into the definitions of both the advantages and disadvantages of a sole trader vs a limited company. Therefore, you shouldn’t miss out if you want to make the best business decisions in the near future.
Who is a Sole Trader?
A Sole Trader (also known as a Sole proprietor) is an individual who owns a business 100%. They’re self-employed and responsible for making all decisions regarding the business. It’s easy to start and register a sole proprietorship.
Enjoying all profits sounds cool, right? Yes, it is, but there are also losses that you take on.
Although being in charge as a trading boss sounds exciting, the role can be daunting since you bear all liabilities when you make poor decisions. However, you don’t have to fret as we’ll help you understand the good and ugly side of a sole trader to make the right decision.
Advantages of a sole trader
Here are the advantages of a sole trader:
- Easy to set up as it requires few legal formalities
- All profits from the business belong to the owner
- Decision-making is exclusive to the business owner
- There’s maximum privacy
- Effortless to establish and run
- Easy to change the organisation’s legal structure
- Low start-up costs
Disadvantages of a Sole Trader
A sole trader also comes with several disadvantages:
- Business failure or liability is the owner’s responsibility
- Limited scope raise capital
- Making business decisions is solely dependent on one person (the business owner)
- Challenging to maintain high-performing employees
- The owner is taxed as an individual by the government
- Only a single person can establish and own the business
What is a Limited Company?
A limited company is abbreviated as Ltd.
Several individuals or organisations run the company. It’s a separate entity from its owners in how it’s run and owned.
Individuals own shares, which makes them shareholders, and the business is run by a group of directors who make decisions about the company together.
Legally, a limited company is separate from those who form it meaning the shareholders or directors have limited liability. It means the losses or problems of the company have nothing to do with the business; hence the term’ limited company’.
If you decide to be a sole trader or non-limited business owner, you can lose your assets whenever the company fails.
However, as you get into a limited company structure, it protects by separating personal assets from the company.
As long as your business is running legally according to the provisions of the Companies Act, personal assets are never at risk.
From that point of view, settling for a limited company looks easy. But before you rush to make your decision, it’s important to understand its pros and cons.
Advantages of a Limited Company
Here are some advantages of a limited company.
1. Minimal Personal Liability
As a limited company, the business is separate from the owners and has its rights. Hence, the entity protects the owners’ business assets when the company faces receivership.
The separation of a limited company and the owners is also known as the ‘corporate veil’.
Whenever the company faces difficulties or legal trouble, it’s by itself. Hence, it’s important to have a professional image for these benefits:
- Winning new clients and investors
- Creating a credible, effective brand identity
- Expanding the business nationally and internationally
- Creating more trading opportunities
- Competing with other businesses
2. Less Taxation
Depending on the country a limited company operates from, it can pay less corporation tax on profits. Paying less tax means fewer expenses and wider profit margins or reinvesting in the business whenever the business needs to expand.
3. Building Credibility and Trust
A professional business structure, like a limited company, is prestigious and credible to potential customers.
Limited companies advertise their businesses publicly which aids the network to attract more clients and investors. When more investors join the industry, there’s potential for growth and expansion.
4. Better Borrowing Opportunities
Borrowing from banks or other lending firms is easy for a limited company.
A limited company has its business information on public record.
Hence, potential shareholders can access the company details anytime for inspection before investing in the business. To get more investment capital, limited companies can increase owners by selling shares.
5. The Business is Separated from the Owner
As separate entities, companies are responsible for their debts and liabilities. Hence, the owners aren’t liable when the company is dissolved or insolvent.
When in trouble, the business can declare bankruptcy and not have a direct impact on the shareholders or directors. Plus, companies enjoy perpetual succession, meaning the demise of members doesn’t affect its existence.
Form Your Company with Incorpuk Today
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Factors to Consider When Choosing a Sole Trader or Limited Company
A sole trading business is easy to set up as it requires less paperwork and obligations.
However, you may face more challenges when it comes to:
- Accessing business funding
- Benefiting from tax reliefs
- Winning more customers
Setting up a limited company is a complicated process and it’s costly, involving more paperwork. However, setting up a limited company exposes the business to many advantages;
- Raising funds
- Boosting your reputation among customers
- Tax efficient
Taxes
In a sole proprietorship, the company’s revenue before taxation becomes the taxable income of the business owner.
For a limited company, directors file important documents like a set of accounts, a company tax return, and a confirmation statement. Additionally, every director files a personal tax return to the taxation company.
A sole trader takes less time to file for taxes as compared to a limited company, meaning they spend little time when dealing with the tax man.
Cost
The business structure you settle for will determine the costs you incur. Both a sole trader and a limited company require different start-up budgets.
A sole trader and a limited company require different start-up expenses.
For instance, the legal charges when setting up a sole proprietorship may be low, while those of a limited company are higher.
Capital Investment
Whilst a sole trader can start small and grow into the business, it’s tough to get funding as an individual.
Considering that a limited company, on the other hand, can raise or increase capital investment through selling of shares.
Licences and Permits
There are different licence and permit regulations depending on the business location and type of structure. It’s up to the business owner to decide what’s convenient for them.
A sole trader may require fewer licences than a person or people owning a limited company.
Privacy
Setting up a sole proprietorship is ideal for anyone considering starting a family business other than a limited company.
For limited companies, the company information is kept on public record, meaning anyone can access it. Before settling on either, you can consult with companies to get clarity on privacy matters offered by each structure.
Legal Formalities
According to the law, a sole trader and a business owner are the same entity. Any liabilities are the owner’s legal responsibility. When the business is unable to pay a creditor, the creditor can take away assets. The same happens when another company or person sues the business.
As for limited companies, the business has nothing to do with shareholders or owners.
Perpetual Existence
A sole proprietorship only exists as long as the sole owner does, while a limited company continues beyond shareholders’ or owners’ death or retirement.
A business owner who travels a lot or is unable to operate a business should consider opening a limited company instead. Why? Because different people run limited companies.
Sole Trader vs. a Limited Company
How do you DISTINGUISH between a sole trader and a limited company? The comparison below will help you get it right.
- A limited company has limited liability, which separates the business from the owners. A sole trader has unlimited liability, meaning they’re liable for business owner is personally liable for any debts.
- Limited companies are more tax-efficient, unlike sole traders, who may pay more taxes.
- Once a limited company is registered, no one else can use the name or anything similar. A sole proprietorship might not offer the same protection.
- A limited company may have more responsibilities that are expensive and time-consuming. A sole trader structure is relatively affordable, easy to operate, and run.
Can a Sole Trader Change to a Limited Company?
Small business owners or self-employed individuals are better off opening a sole trading business. The business is easy to set up as well as operate. However, when the time comes and you decide to switch to a limited company, it’s possible.
But why would you want to change from a sole trader to a limited company? Here are a few reasons.
- Profits are increasing, and you want a more tax-efficient structure.
- Looking to get more business funding.
- Seeking to boost your business’ credibility to potential customers.
- To bring new talent and shareholders on board.
Frequently Asked Questions
How do a sole trader and a limited company differ in terms of shares?
A sole trader owns the business 100%, while a limited company issues shares to multiple people who become shareholders. Although sole traders are flexible to run, the owner bears all liabilities since they are one entity with the business. Limited company owners’ assets are separate from the business, making the industry a limited liability.
What is the main advantage of a sole trader over a limited company?
Sole traders only complete an annual Self-Assessment tax return, and they won’t have to file accounts. Hence, they have some privacy. Companies House records the details of limited companies, making them accessible to the public. Thus, there’s no privacy for the information limited companies use to register a company.
What is different about a sole proprietor to a partnership?
A sole proprietor owns an entire business and makes decisions alone. Partnerships involve multiple people who form an agreement on how to run the business and ways to regulate disagreements in favour of the company.
What is the main difference between a sole trader and a limited company?
An individual owns a sole trader, whereas a private limited company is separate from the owners or shareholders. When a sole trader can’t pay debts, the owner is liable. As for a limited company, the business is independent from the owners.
The Bottom Line
The business structure you decide to venture into is a personal decision, but the pros and cons of each should guide you into making the right decision. While sole traders are self-employed business individuals, limited companies can have as many members as possible. Although setting up a sole trading business is easier and affordable than a limited company, the limitations that come with the structure may not be favourable. Do you have a question about Sole Trader and Limited Company? Contact us here for answers to your questions.