Company Set Up: limited company or sole trader? What’s right for my start-up?

Setting up your new company

One of the most important things to consider at the outset if you are planning on setting yourself up in business is whether you set-up as a sole trader or Ltd company.

It’s important to note that there are two types of business set-up for you need to consider. Sole traders who are one man/woman businesses or Limited Companies which give impression you are a more established larger company with ambitions to grow.

Here is an overview of overview both in simple terms:

What is a ‘sole-trader’?

A sole trader is formally recognised by HMRC as being in business for themselves.

It’s common for such people to refer to themselves as self-employed or as freelancers, but the official term is ‘sole trader’.

When you register with HMRC as a sole trader, you must agree to keep appropriate financial records and pay all taxes due. This means tracking eligible expenses, issuing invoices for all work done and submitting self-assessment returns that confirm your taxable income.

Unlike being a traditional employee of another organisation, where tax is usually deducted at source through the Pay As You Earn (PAYE) scheme, sole traders use self-assessment to calculate their tax burden and pay this to HMRC twice a year.

In addition to these tax payments, sole traders usually need to pay Class 2 and Class 4 National Insurance Contributions (NICs). The amounts are calculated automatically when you submit your self-assessment form online. You can find out more about this on the government’s Self-employed National Insurance rates page.

How do you set-up as a ‘sole-trader’?

The quickest and easiest to set-up, you can sign up online via the .GOV website for tax, self-assessment, and National Insurance, along with VAT if it’s applicable (for yearly turnover over £85K).

You run your business as an individual and are self-employed, there is less paperwork, and the accounting process is simpler.

You can keep all your business profits once you have paid the taxes already mentioned though you are personally liable for any losses your business makes.

What are the benefits of being a ‘sole trader’?

It’s easier to set up as a sole trader

Perhaps that’s why there are approximately twice as many sole traders as there are limited companies in the UK. There’s less paperwork associated with being a sole trader (though you still must complete an annual tax return), and you don’t need to register with Companies House.

Sole traders have a greater level of privacy than limited companies

If you set up a limited company, some of your personal details will be published in the records of Companies House. However, that doesn’t mean that sole traders are anonymous. Remember that you’ll need to put some information out into the public domain if you’re to market your business effectively.

What is a ‘limited company’?

A limited company has its own legal identity and is structured as a business that has shareholders and directors.

A limited company can be run by just one person, but the setup is more involved than being a sole trader.

For limited companies run by an individual, the person in question becomes the director of the company as well as its only shareholder. That person then takes their remuneration in the form of either a salary or dividends or a mix of both from the earnings of the business.

To set up a limited company, you need to register with Companies House. That means your full name, address, and date of birth, well at least month and year will be published for all to see. The same is true for all directors in the UK, even for those who serve as directors in not-for-profit organisations.

When registering as a limited company, you agree to file an annual confirmation statement and company accounts, both documents are on the public record.

How do you set-up a limited company?

The main bonus being that your business affairs are separate from your personal ones. Therefore if your business gets into financial difficulty, you only lose money invested. Company Directors pay themselves a salary through payroll and top up with dividends (profit) from the business. You can be a one-person business and as director you are responsible for any legal and financial decisions your company makes. Again, the process is simple to get you set-up via the Companies House website.

What are the benefits of being a limited company?

Limited companies may feel more trustworthy to some clients

A limited company can give the impression of a greater sense of permanence and financial success, and that can influence clients to favour working with a limited company over a sole trader.

Limited companies have limited liability

Financial liabilities are placed on the company rather than on the individual(s) running the company. Generally. that means your personal assets aren’t at risk if you run a limited company.

Limited companies can be more profitable for some businesses

As your earnings increase, it can be financially advantageous to operate as a limited company rather than as a sole trader.

Limited companies pay corporation tax rather than personal income tax, and you have far more flexibility in terms of how you remunerate yourself. You will afford yourself more tax planning opportunities and potentially save more by taking advantage of a greater range of tax-deductible items.

Those who plan for gradual growth sometimes start a business as a sole trader and then switch to becoming a limited company. We mention this to make clear that your choice isn’t fixed – you can change your mind and business owners often do.

Limited companies have greater protection over their names

Setting up a limited company with Companies House means that your business will be the only one allowed to register and use the name you’ve chosen.

Note that you may still need to apply for a registered trademark if that’s relevant to your business.

Sole traders aren’t offered this sort of protection because you can’t legally prevent someone with the same name from using that name in their business.

What’s right for you?

There isn’t a right or wrong option, which you choose depends on your personal circumstances and vision for the business. I decided to set-up as a Ltd company as I always had aspirations to grow though you can set-up as either and then worst case scenario you can always transition to the other if circumstances change.

On this basis I would suggest that after you have done some research it’s well worth having a conversation with an Accountant to validate your thoughts and make sure you get it right.

Looking back, I made some schoolgirl errors at this point so my advice would be to make sure you take time to look into this properly before you set-up.