Starting a new business requires a lot of work, time and money. There is no one-size-fits-all formula for a successful start, but there are many things you can do or try to avoid to kick off right. Choosing the right legal structure is crucial to build strong foundations for your business as it grows.
One of the many important decisions to make when launching a new business is choosing a legal structure. And it is not just a matter of picking one which you think is right; you must choose the right formation to secure the success of your business.
In this blog, we discuss the differences between a sole trader and a limited company and why it’s important to have the right legal structure in place from the outset.
Legal structure
The four main business structure types in the UK are:
- Sole Trader
- Limited Company
- Partnership
- Limited Liability Partnership (LLP)
Choosing the right one can be confusing, which is why you need to research all the advantages and disadvantages of each. Decisions need to be made from a legal and financial perspective to get a good all-round idea of what formation is right for you. There is no blanket right or wrong answer because everyone’s circumstances are going to be different.
The difference between a sole trader and a limited company
Once you are presented with all the possible options, it all comes down to understanding the structure and whether or not it’s going to work for your business.
Sole trader
Most businesses in the UK operate as sole traders. A sole trader or “self-employed” is an individual who sets up and runs a business on their own. However, this doesn’t mean that a sole trader works alone. They can still hire staff as long as they inform HMRC and follow relevant employment law regulations.
As a sole trader, you need to report to HMRC as self-employed and register to pay self-employed tax. The income tax on your profits is taxed 40 per cent for profits above £45,001 and 45 per cent for profits above £150,000.
Some of the advantages of operating as a sole trader include the following:
- Immediate start. This means you don’t have to register with Companies House. You can start working straight away.
- No fees to register
- Less paperwork with few formalities
- A simple way of paying taxes with a few accounting responsibilities
- Full control of your business decisions
- Get to keep all profit for yourself after taxes
- Your financial information is private
While setting up a sole trade business is the simplest option, the UK law sees the business owner and their business as one legal entity, meaning the sole trader is liable for everything concerning the business, personal and business debts included. What this essentially means is that if your business gets into financial difficulty your personal assets, such as your home, are at risk.
Limited company
If you choose to operate your business as a limited company, you have to register with Companies House. This alone means that certain financial information is accessible by anyone through Companies House due to an obligation to file annual accounts.
One of the advantages of being a limited company is that the business is seen as a different legal entity, legally separate from the shareholders and directors. This means that any personal assets are protected. Other advantages include the following:
- Less personal tax. Since the company profits are subject to UK Corporation Tax, companies pay a lower rate of 19 per cent on their profits.
- Funding. Unlike sole traders, a limited company has more access to funding
- Credibility. Most businesses prefer working with a limited company over a sole trader due to the level of legal protection, which encourages more trust among customers and suppliers
However, there are a few drawbacks to setting up a limited company, such as:
- Lots of paperwork
- Costly and time-consuming process
- Less privacy
- Knowing your legal obligations to ensure you comply with the legislation which governs limited companies, the Companies Act 2016.
As lawyers, we will always explain that a limited company will be better because of the limited liability and therefore, in most circumstances, your personal assets will be protected.
However, that isn’t going to be the only consideration, weighing them all up and making an informed decision is the best thing to do.
Final thoughts
Choosing the right legal structure for your business is an important but difficult step. Before making the decision, you have to research all the pros and cons and see which business setup will be the right one for you.
If you are looking to start a new business, the numerous challenges you have to face can be a little overwhelming. For that reason, we have created our Startup Guide, a Startup Mastery that works like a handy manual which you can refer to every time you feel stuck. It covers company formation and lots of other helpful sections such as Funding, Marketing, Intellectual Property, GDPR, Banking, Insurance and many more helpful sections to get your business off to a great start.
Finally, if you feel that you need more advice about which legal structure to choose, we are available for 15 and 30 minutes consultations. Don’t hesitate to book an appointment. Looking forward to hearing from you!