Sole Trader Vs Limited Company

Starting a business is an exciting time and there’s a lot to think about. It’s important to have a checklist before you start and ensure you’re clear on your business aims and plans.

Before you even get that far, however, the question for many individual start-ups is whether to set up as a limited company or sole trader. It’s a very important decision, mainly because it has significant implications in terms of legal, financial, and tax considerations in the future.

In this article, we’re covering: their definitions, the respective pros and cons, and how they differ from each other. By the end of the article, you’ll understand both legal structures and know which is best for you. 

1. What's the difference between a sole trader and a limited company?
2. Pros and cons of being a sole trader
3. Pros and cons of being a limited company
4. Which one is better for you? Sole trader or limited company…
5. Is it possible to change from being a sole trader to a limited company?

1. What's the difference between a sole trader and a limited company?

The main differences between a sole trader and a limited company are:

• Legal distinction: A sole trader is a self-employed person who is the sole owner of their business and there is no legal distinction between the owner and the business. In contrast, a limited company is a separate legal entity from its owners (shareholders), and the company can enter into contracts, borrow money, and own assets in its own name.
• Liability: As a sole trader, you are personally liable for any debts or legal issues that arise in your business. In contrast, a limited company is a separate legal entity, so your personal liability is limited to the amount of money you have invested in the business.
• Taxes: A sole trader pays income tax on their business profits, while a limited company pays corporation tax on its profits. There are different tax rates and rules for each.
• Ownership: A sole trader owns the business outright and has full control over it. In a limited company, ownership is divided into shares, and shareholders own the company proportionate to the number of shares they own. Shareholders have a say in major decisions, such as appointing directors, but the day-to-day running of the business is usually delegated to the directors.
• Accounting and reporting: A sole trader must keep records of all business transactions and report their income and expenses to HMRC each year. A limited company must file annual accounts with Companies House, which must include a profit and loss statement, balance sheet, and other financial information.
• Perceived credibility: A limited company can sometimes be viewed as more credible than a sole trader, especially when dealing with larger clients or customers.

2. Pros and cons of being a sole trader

Sole traders account for 4.175 million businesses in the UK out of a total of 5.583 million SMEs, which in turn account for 99.9% of all businesses.1

Statistically speaking, it’s the most popular option but that doesn’t necessarily mean it’s right for you.

Here are the pros and cons so you can understand the potential benefits and drawbacks.

Advantages of being a sole trader

• Simplicity: Starting a sole trader business is generally less complicated than starting a limited company. There are fewer legal and financial requirements to fulfil, making it an easy way to start your own business.
• Control: As a sole trader, you have complete control over your business. You can make decisions quickly and easily without having to consult with shareholders or directors.
• Flexibility: Sole traders have the flexibility to change their business direction, services or products offered, or working hours to suit their needs or market demand.
• Cost-effective: As a sole trader, you do not have to pay fees to incorporate your business, or for the ongoing maintenance and legal fees that come with running a limited company. This can make it more cost-effective to run your business.
• Personal touch: Being a sole trader allows you to build personal relationships with your customers and suppliers, which can help build loyalty and long-term business relationships.
• Tax benefits: Sole traders may be eligible for certain tax benefits, such as being able to claim tax deductions for expenses incurred while running their business.
• Privacy: As a sole trader, you do not have to disclose financial information to Companies House or to the public, which can help maintain your privacy.
  Overall, being a sole trader can be an attractive option for those who want to start their own business without having to deal with the legal and financial complexities of running a limited company.

Disadvantages of being a sole trader

• Personal liability: One of the biggest disadvantages of being a sole trader is that you’re personally liable for any debts and legal issues that arise in your business. This means that your personal assets, such as your house and car, could be at risk if something goes wrong.
• Limited growth potential: As a sole trader, your business is limited by your own skills, time, and resources. It can be difficult to scale the business beyond a certain point, as there may be limitations on the amount of work you can handle alone.
• Lack of credibility: Some customers may view sole traders as less credible than limited companies, which could make it harder to win larger contracts or establish business relationships.
• Lack of support: Being a sole trader means you’re responsible for everything in your business, from administration and accounting to marketing and customer service. This can be overwhelming and time-consuming, especially if you’re trying to manage everything on your own.
• Limited financing options: Sole traders may have limited financing options compared to limited companies. This could make it difficult to raise capital for investment or expansion.
• Personal stress: As a sole trader, you’re responsible for everything in your business. This can be stressful, especially if you’re working long hours or struggling to make ends meet.

Overall, while being a sole trader offers flexibility and control, it also comes with a range of disadvantages. Therefore, it’s important to carefully weigh up the pros and cons before deciding whether to start a sole trader business.

Back to top

3. Pros and cons of being a limited company

A limited company is a type of business entity in which the company is considered a distinct legal entity from its directors and shareholders. If the company is managed by a single individual, they serve as both the sole director and shareholder.

Advantages of being a limited company

• Limited liability: One of the biggest advantages of being a limited company is that it provides limited liability protection to its shareholders and directors. This means that their personal assets, such as houses and cars, are separate from the finances of the business, reducing the risk of personal financial loss.
• Credibility: Limited companies are sometimes viewed as more credible than sole traders, which can help establish business relationships and win larger contracts.
• Potential for growth: Limited companies have the potential to grow and expand more easily than sole traders, as they can raise capital by selling shares or taking out loans.
• Tax benefits: Limited companies may be eligible for certain tax benefits, such as claiming tax deductions for expenses incurred while running the business.
• Greater access to funding: Limited companies tend to have access to a wider range of funding options, including equity investments and bank loans, making it easier to raise capital for investment or expansion.
• Perpetual existence: A limited company has perpetual existence, meaning that it continues to exist even if the shareholders or directors change.
• Separation of ownership and management: Limited companies have a clear separation of ownership and management, allowing shareholders to focus on investing in the business while the directors manage the day-to-day operations.

Overall, being a limited company offers significant advantages in terms of liability protection, credibility, and potential for growth. However, it also comes with more legal and financial requirements, making it more complex to set up and manage than a sole trader business.

Disadvantages of being a limited company

There are several disadvantages to being a limited company:

• Increased regulatory requirements: Limited companies are subject to more complex legal and financial regulations than sole traders, which can increase the administrative burden of running the business.
• Higher set-up and operating costs: Setting up and operating a limited company can be more expensive than a sole trader business due to the need for legal and financial services.
• Greater accountability: As a limited company, shareholders and directors are held to a higher standard of accountability, which can make it more difficult to make decisions or take risks without considering the impact on the business as a whole.
• Reduced control: Shareholders and directors may have less control over the day-to-day operations of the business than a sole trader, as they may need to consult with other stakeholders before making major decisions.
• Public disclosure: Limited companies are required to file annual financial statements with regulatory authorities, which are then made publicly available. This can limit the company's ability to keep financial information private.
• Increased scrutiny: Limited companies may be subject to greater scrutiny from regulatory authorities, tax authorities, and the public, which can create additional pressure and stress for shareholders and directors.

Overall, while being a limited company offers liability protection and potential for growth, it also comes with a range of disadvantages. Therefore, it’s important to carefully consider the pros and cons before deciding to set up a limited company.

Back to top

4. Which one is better for you? Sole trader or limited company…

Deciding whether to operate as a sole trader or a limited company ultimately depends on the specific needs and circumstances of your business. There is no one-size-fits-all answer to this question.

If you’re starting a small business with low start-up costs and you’re comfortable with taking on the risks associated with personal liability, then operating as a sole trader may be a good option. This structure is generally less complicated, with fewer legal and financial requirements, making it easier to get started and run.

On the other hand, if you’re planning to expand your business and need to raise capital or reduce personal liability risks, then setting up a limited company may be a better option. This structure provides greater separation between personal and business finances, as well as the potential for growth and greater credibility.

In addition, the choice of whether to operate as a sole trader or a limited company may also depend on your personal tax situation. Tax implications can differ between the two structures.

Ultimately, it’s important to carefully consider the pros and cons of each structure and seek professional advice if necessary before deciding which option is right for you and your business.

Back to top

5. Is it possible to change from being a sole trader to a limited company?

Yes, it is possible to change from being a sole trader to a limited company. This is known as incorporation.

To change from a sole trader to a limited company, you’ll need to register your new company with Companies House and apply for a new business bank account. You’ll also need to transfer any assets and liabilities from your sole trader business to the new limited company.

Incorporation can have legal, financial and tax implications, so we recommend you seek professional advice from a solicitor or an accountant before making the transition.

Additionally, if you’re registered for VAT as a sole trader, you’ll need to cancel your registration and re-register as a limited company. You may also need to notify HM Revenue and Customs (HMRC) of the change and update any relevant tax records.

Back to top

Key takeaway

If you’re still unsure about which way to go with your business, you might be best consulting a qualified accountant. That way, you can explain your exact scenario to a professional and get relevant advice of how best to proceed.