16 February 2023
Sole Trader vs Limited Company: The Benefits and Drawbacks
Whilst the prospect of setting up your own business is a hugely exciting one, it can appear daunting to begin with. One of the first decisions that must be made relates to business structure, namely whether you should operate as a sole trader or as a limited company. Whilst there is no universal one-size-fits-all approach there are of course benefits and drawbacks to both options. Before making such an important decision, it is crucial to understand what each of these structures looks like, and to ensure you are aware of their respective advantages and disadvantages as well as the similarities and differences between the two.
What is a Sole Trader?
As a sole trader there is no legal separation between you and your business; you are one single legal entity. Many individuals in the initial stages of business set-up may decide to start as sole traders to begin with, before eventually incorporating their businesses to become limited companies, if things run smoothly and the business shows promise in regard to growth and development.
Advantages of Operating as a Sole Trader
A main advantage of operating as a sole trader is the complete control that can be exercised over the business by the business owner, enabling fast and efficient decision-making, as well as the ability to keep all of the business profits after tax.
This structure also appeals to many due to the lighter administrative burden. Sole traders must complete an annual self-assessment tax return, but there is no requirement to file accounts. Not only does this ensure a certain level of simplicity in establishing and operating the business, but it also helps to preserve its privacy which many business owners find attractive; there is no obligation for sole traders to disclose any information on public registers whereas limited companies must upload certain information to Companies House.
Disadvantages of Operating as a Sole Trader
Whilst the elements listed above can appear advantageous to a prospective business owner, their ability to cause difficulty must not be understated. Unfortunately, the nature of this business structure means sole traders do not benefit from limited liability, and as such will be fully, personally liable for any loss the business makes. This is a daunting prospect which steers many entrepreneurs away from setting up in this way, although it is worth bearing in mind that insurance may be available in order to mitigate part of the risk.
Furthermore, being solely responsible for all business decisions and having no one to share this accountability with is a huge drawback, and can cause high levels of pressure on an individual.
What is a Limited Company?
The shortcomings of operating as a sole trader might cause entrepreneurs to consider the alternative business set-up options available to them. A limited company is a separate legal entity with its own identity, separate from its owners and shareholders.
Advantages of Operating as a Limited Company
Arguably the main benefit of a limited company is the limitation of personal liability. This means that it will not be the personal responsibility of the shareholders, should the business incur huge debt or losses. This may increase the likelihood of a business owner taking risks, which can in turn result in greater reward in the form of business growth and development.
Limited companies also have increased borrowing and investment opportunities when compared with sole traders. For the former, capital can be raised through sale of shares, whereas the latter cannot seek outside investment unless they embark upon the complex process of turning their business into a partnership. For a limited company, the ability to raise capital in this manner can create many more business opportunities and can drastically increase business growth.
A further advantage to choosing this structure is reflected in the ability of a business owner to pay themselves a salary or dividends from the company’s profits for which we recommend this guide on how to generate withholding tax form to complete payments.
If you Can’t pay dividends to directors and shareholders, then if a shareholder has invested in the company with a view to receiving regular dividend payouts, failing to receive the anticipated return may results in the sale of their shares. As the business grows, this may be more tax efficient, as a limited company making a profit will be subject to Corporation Tax, which will minimize income tax and National Insurance contributions.
Disadvantages of Operating as a Limited Company
This method of business operation does not come without its own disadvantages though. Becoming incorporated will bring added administrative responsibilities that can be time-consuming and costly, and the tax requirements may be more difficult. Owners will also be unable to retain the same level of control as a sole trader, which will not suit all entrepreneurs.
Which is Best For You?
Overall the best way forward for setting up a business will depend on a variety of individual factors and circumstances. Therefore there is no one ‘best’ or ‘right’ option, as this will vary from business to business and person to person. Here at Cook Corporate we can give expert advise on the best method of trading and corporate structure based upon your individual circumstances.