Becoming a sole trader may well be a popular and easy route to ‘becoming your own boss’, but it’s not the only one. There are some clear advantages of being a limited company over those of setting up as a sole trader.
In order to become a limited company, you will need to become incorporated at Companies House, which is essentially the legal registration of your company. Whilst this may sound like a faff compared to being a sole trader, you will be pleased to know that setting up a limited company is relatively simple process (there are plenty of companies that make this very easy for you – for a small fee of course). You can do it as an individual owner and it legally separates you as the owner from the business, which brings with it a whole host of benefits, the biggest being limited liability which massively reduces your personal risk in the event the business fails or racks up debt. There are pro’s and con’s for any business structure and you will need to decide which works best for you and your situation.
Advantages of being a private limited company
Personal protection through limited liability
One of the biggest advantages of being a private limited company is that it offers you personal limited liability. That is, you are not personally liable for debts the business may incur. Your personal finances and assets are protected so if the business gets into debt it cannot pay, you will not have to use personal assets to cover the debt. However, depending on how much you personally depend on the business for your income, you may choose to bail it out from your personal finances, but that is a choice rather than something that is imposed on you.
All business carries some risk and at times you may need to speculate to accumulate. As a limited company, if the worst happens then you only lose the business and anything that is part of that business (including what you put into it). This is in contrast to a sole trader where poor decisions could leave you facing the loss of your personal savings and assets such as your home, not to mention potentially being declared bankrupt. It is, however, worth noting that even as a limited company, if creditors (those you owe money to) lose money through fraud you’ve committed as an owner then you will have personal unlimited liability, so it pays to be good.
More tax efficient
Unfortunately we all have to pay taxes but it’s always nice when you can find ways to pay less (through legal ways that is). Another of the major advantages of being a private limited company is that you are more likely to be able to find tax savings than a sole trader. One of the biggest areas is around pay and business profits. As a limited company owner you can take the maximum within the tax free threshold (£12,500 for the 2020/21 tax year) and then take the remainder of your income through dividends (distribution of business earnings to shareholders). Dividends are taxed at a lower rate than income tax thresholds and you don’t have to pay National Insurance Contributions (NIC’s) against them. You will, however, need to pay Corporation Tax on any profits the business generates in the financial year (which currently stands at a 19% flat rate). A sole trader doesn’t have dividends, business profit is simply taxed at the relevant income tax threshold (20-45%), which you begin to pay at 20% when you earn over £12,500, with the tax rate increasing as your profits increase and NIC’s also being taken.
As you can see from below, in some cases and on its own, the tax savings may not be sufficient to make being a limited company an advantageous.
| Profits | Sole Trader Tax | Limited Company Tax | Tax Saving |
|---|---|---|---|
| £20,000 | £2,679 | £2,420 | £249 |
| £30,000 | £5,679 | £4,927 | £652 |
| £40,000 | £8,679 | £7,435 | £1,044 |
| £50,000 | £11,679 | £9,942 | £1,437 |
| £60,000 | £15,679 | £12,507 | £3,072 |
| £70,000 | £19,679 | £17,040 | £2,739 |
| £80,000 | £23,679 | £21,572 | £2,407 |
| £90,000 | £28,679 | £26,105 | £2,074 |
| £100,000 | £32,679 | £30,637 | £1,742 |
*based on 2020/2021 tax rates
Invest in your company pension
We should all think about our futures but this may be difficult as a sole trader to find the funds to invest in pension given the way in which profit is taxed at the standard income tax rates. As the owner of the limited company, you can invest pre-tax sum into a company pension scheme, which means you don’t pay the 19% corporation tax or the personal tax on the pension investment, effectively saving money rather than taking it out as payment – another way of making the most of reducing your tax bill (even though you can’t get it until you retire).
Maximise tax-free income
As the owner of a limited company you still have the same tax-free income as a sole trader (£12,500 in 2020/2021). However, having a limited company will allow you to maximise tax-free income, by having your husband/wife/partner and children as shareholders (they don’t need to be equal shares to you, they can be minimal percent shareholders, so don’t worry about boardroom takeovers). This effectively means that each person can take a tax-free salary of up £12,500 (provided they are not receiving other taxable pay from elsewhere that would take them over the threshold). For example, if a husband and wife take salary up to the amount of the tax-free income, they can accumulate £25,000 all tax-free. Being able to work your way around tax and maximise your income is one of the great advantages of being a private limited company.
Secure your trading name
Put simply, when you register your business with Companies House, your business name is legally protected (assuming it’s not similar to someone else’s or infringes on a registered trademark – always worthwhile to check first). There can only be one company in the UK with the same name or anything that is deemed too similar. As a sole trader, your business is not registered with Companies House and has no legal protection for the name, meaning that others are free to use it and there is not a lot you can do to stop them. If you have multiple businesses in the UK with a similar or the same name, as is the case with many sole trader businesses, it is easy to see that the actions of one may impact the reputation of another via association with the name, which is unfortunate but does happen.
Higher perceived credibility
Credibility can be key in business, especially when it comes to convincing new clients or customers to do business with you. Just the title of a limited company can instill confidence in your business. Some clients, particularly larger ones, may prefer to work with limited companies with some refusing to work with sole traders. Being a sole trader therefore may discount you from a number of business opportunities that could be the fine line between success and failure. Like the big kid in the playground, limited companies look bigger. Whilst there may only be one person behind the operation, a limited company status can mask this making it easier to win new business and secure funding from banks.
It’s quick, cheap and easy to setup
Forms and legalities can put a lot of people off forming a limited company, but it really shouldn’t. With the aid of online services that cater for business setups, you can register a new business in less than 10 minutes and for as little as £10 (sometimes less). This will take care of the formality of registering your business with Companies House but it is up to you to make sure you have adequate funding to run your business.
Easier access to finance
There are easier ways to secure funding for your business than robbing a bank. Being a limited company may (although not always) make it easier to secure funding and finance compared to that of a sole trader. In addition to the credibility aspect of a limited company, you are unlikely to need to present any personal bank records as part of any lending. As a sole trader, the lack of distinction between you personally and the business means that your financial position will affect the lending to the business – you may put a label of a business on it, but the bank is lending to you personally.
If it is in the position to and can secure investors, a limited company can raise capital by issuing new shares to shareholders and new investors – to anyone, really, except Joe Public (only public limited companies can do that). On the other hand, sole traders have to raise new capital from their personal resources. If they happen to be cash-strapped at the time, that’s pretty much that.
Protecting a business name for future trading
A small point but one worth noting. If you have a business idea but are not ready to start the business (either you need to secure funding or its just not quite the right time), you don’t need to give up on your dream. You can setup a dormant company and put the business on hold and protect its trading name in the process so no-one else can beat you to the punch. A dormant company is one registered with Companies House that doesn’t trade and takes no significant accounting transactions during a financial year.
Easier to sell or transfer ownership
Perhaps you’ve had enough of working and you want to cash in on your business and live a life of luxury. You might not be able to live the life of luxury, but as long as your business has a value to someone, you can sell or transfer its ownership to someone else (or at least your stake in it if you have multiple stakeholders). You don’t even need to sell it whole; equipment, premises and clients can all be sold separately if required. For a sole trader, this is incredibly difficult as the business is interlinked with them as a person making it hard to sell or for anyone else to pick-up.
While there are many compelling advantages of being a private limited company, it is useful to understand the potential disadvantages of being a private limited company against the advantages of being a sole trader.