Sole Trader or Limited Company?
Sole Trader or Limited Company?
Sole Trader
A sole trader, is just that. A lone person that runs their own business. Registered as self-employed with HMRC, they quite often run a small business from their home. Starting up a business as a sole trader allows a person to have full control of their own business. In the eyes of the law, the business and the owner are one and the same. This can have legal ramifications in the event of any financial liabilities.
People quite often prefer to start business as a sole trader because they are under the misconception that carrying out a company formation is an expensive process. They think it would just be easier to run their business as a sole trader. In some cases this might well be true. Sole traders are subject to less stringent rules, reporting requirements and other laws which a limited company has to abide by. The result is that a sole trader can be more flexible and easy to manage.
However, there is an opposite side to the business. Sole traders often find it difficult to raise finance for their business. Banks and other lenders are less willing to loan small amounts to sole traders. Other businesses (especially larger limited companies) will be less willing to do business with a sole trader. The main disadvantage is the unlimited liability that goes hand in hand with being a sole trader. Any debts run up by the business will rest on the shoulders of the business owner. Which in the worst case scenario could mean a business owner finding themselves at risk of losing their house.
Limited Company
Carrying out a company formation allows an entrepreneur to establish a new business entity which the law views as separate from the business owner. The main and most common advantage of this is limited liability. Being a separate body, any debts that the company accrues are seen as detached from the owners. So this offers protection to their private assets.
Limited liability is seen as the most favourable advantage of forming a limited company instead of running a business as a sole trader, but it is not the only one.
When asked their reasons for wishing to form a limited company, a surprising number of people will state that it is a perception thing. Limited companies have a perceived image. People tend to think that they are more trustworthy. Dealing with customers, other businesses and even employees is easier as a limited company. People are naturally more inclined to deal with a company, than a business run by a sole trader. There is no actual proof that a limited company is more trustworthy, it is simply a matter of perception. It is however true that it is easier to acquire finance as a limited company than as a sole trader. People are often far more willing to invest in a business with limited liability. The other advantage is that registering a business as a limited company allows a business to take advantage of the larger business image naturally attributed to a company. People unwittingly assume that a limited company is a big business, not a one-man-band operation. However, it is perfectly plausible to set up a company with just one director.
There are however some downsides to using the limited company form over running a business as a sole trader. Directors of limited companies are subject to more rules and regulations regarding their conduct and running of the business. These rules are in place to prevent abuse of the limited liability aspect of the company, but also to ensure that the directors act in a way which is in the best interests of the company and therefore its shareholders.
As already mentioned, there are also stricter rules when it comes to the submission of accounts and reports. Companies failing to comply with the rules could find themselves facing financial fees in the form of late filing penalties and even, in the worst cases being struck off the company register.
On the other hand, using a limited company allows a business to take advantage of the tax efficient nature of this business model. The way taxes are paid, a director may pay himself partly in dividends and partly by PAYE, thus reducing the amount of income tax he pays. This can mean that a director of a company is subject to far less tax than a sole trader who would face paying tax at the higher personal rate.
Which is best?
In a number of cases, the industry sector the business operates in will have an influence on the choice of business entity. For example, IT contractors who operate as self employed often find that their client companies unwilling to deal with them as they only operate by invoicing limited companies (see our article on Umbrella Company Vs Own LimitedCompany).
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