Sole trader or limited company ? This is the question
Have you been wondering whether you should trade as a sole trader or whether you should incorporate your business as a limited company ? What’s the best choice? Many business owners struggle with these questions. In this blog we will attempt to look at advantages and disadvantages of trading as a sole trader and of trading as limited company.
Trading as a sole trader is usually the form that most business owners start with on their business journey. They may think their business idea is not yet very clear or just a wee hobby so why complicate matters before it becomes evident whether they will continue on this path or not. Or maybe they are engaged in a trade in which they mostly work alone, like a professional photographer or a plumber.
Advantages of trading as sole trader:
- As a sole trader, you are the owner of your business. You are independent and can run the business without the need to consult others and obtain their approval.
- After payment of business expenses, all the profits belong to you, the owner
- If your business is small, and you have only a few, if any, employees, your personal service and supervision are available at all times
- The business is easy to establish legally – either using your name, or a trading name such as “The Fashion Shop” or “Smith Design & Alterations”
- Your financial statements are private, not available to the public
Disadvantages of trading as sole trader:
- You have unlimited liability for the debts of the business. This means that if the business should go bankrupt, your personal assets may be used to pay business debts
- All losses of the business are your responsibility
- Expansion of the business is limited because it can only be achieved by you ploughing back profits or by borrowing from a lender, such as taking a bank loan
- You usually have to work long hours and it may be difficult to find time to take holidays. If you become unavailable because of illness or attending family matters, the business will either slow down or stop altogether.
- Taxation rules are quite complex for sole traders. They pay 20% tax on all their deductible income when it is up to £37500 from employment as well as self-employment, however when their deductible income is higher than £37500, they pay 40% tax, and when their deductible income is higher than £150000, they pay 45% of all deductible income.
A business is incorporated by being formed into a legal entity separate from its owners. There are two main types of business with incorporated status:
- Limited Liability Partnerships (LLPs)
- Limited Companies (Ltds)
A limited company is a separate legal entity, owned by shareholders and managed by directors. Limited companies are more complex businesses to set up and run.
Limited companies are not, however, just for larger businesses. All is needed to form a limited company is just one person.
Here are some advantages and some disadvantages of trading as an incorporated business:
Advantages of trading as limited company:
- The main advantage of incorporation is, without doubt, the limit on the liability for members (LLPs) and shareholders (limited companies) to the amount of their investment. This means that if the business should go bankrupt, your personal assets cannot be used to pay business debts, you will only lose your investment in the business. Shareholders are thus safe; their personal assets unless pledged as security to a lender, are not available to pay the company’s debts.
- The business continues its existence as a separate legal entity. This means that, for example, if legal action is taken, it proceeds against the company and not against the individual shareholders.
- The business beneficiates from an enhancement of its credibility. This means that an incorporated business sounds like a more substantial business than a sole trader.
- Access to finance may be easier for incorporated businesses
- Transfer of ownership of the business may be easier, for example, the sale of shares in a limited company
- Tax on business profit after allowable expenses have been deducted is 19%.
Disadvantages of trading as limited company:
- The main disadvantage is the more complex requirements of setting up the business and then the higher costs of keeping up with record keeping and annual returns
- Financial information filed with Companies House is in the public domain so anyone can access financial and other details
- Business finances must be kept entirely separate from those of the owners, which contrasts with a sole trader who can take drawings from the business as and when required