The sole trade route may be the preferred pathway for many people starting out and running a business, but there are definite advantages to be gained by operating as a limited company instead.
According to the latest stats over at Companies House, there’s a shade more than 4 million incorporated companies in the UK and roughly 93% of them are active.
Here are some of the main reasons why setting up a limited company, or to give it it's posh name, 'incorporation', might be given the nod over sole trader status.
You get protection through limited liability
Taking calculated risks is part and parcel of doing business, whether you’re a sole trader or a limited company, but only the latter insulates you from you a calculated risk gone wrong. The former will leave you out in the cold.
Since time immemorial (well, 1897), the law has said that a limited company has its own legal personality, which is separate from the people who make up the company itself. This means that third parties, such as clients and suppliers, enter into contracts with the corporate entity rather than individual directors and shareholders.
The huge plus point of this legal distinction is that, if you run a limited company as a director, you have limited (capped) liability for its debts, which normally works out to the amount you paid for the shares coupled with any unsecured loans made to the company. So, if the company runs into trouble or even goes belly-up completely, you won’t be personally responsible for any of its financial losses. One exception to the rule is if the company’s creditors lose money through fraud you’ve committed as a director, in which case you’ll incur unlimited personal liability.
By contrast, sole trader status affords no protection from financial claims if a business goes south, because a self-employed person and their business are treated as a single entity for tax and admin purposes. They have potentially unlimited personal liability for their business debts and, in certain circumstances, even their homes may be on the line.
Tax and National Insurance efficiency
Given Benjamin Franklin’s famous quote that there are only two things certain in life - death and taxes - any opportunity to lower tax payments is always a welcome one.
As a director of a limited company, if you take a small salary and most of your income comes in the form of dividends, you’ll still be entitled to State Benefits without paying any employer or employee National Insurance Contributions (NICs).
Dividends attract less tax than salary and aren’t subject to NICs, whereas a sole trader’s entire income is subject to NICs. We explain all this further in our article 'How much should I take as a salary from my limited company?'.
With a limited company, higher take-home pay is clearly the order of the day (see our Take-Home Pay calculator for more detail). However, changes to the dividend taxation system over the years have seen some of the tax benefits reduced, and limited company shareholders facing higher taxes. But, for many people, it can still be more tax-efficient to operate as a limited company. The latest rates and some worked examples are in our article ”What tax do I pay on dividends?".
Confidence is critical in business and a limited company has a veneer of professionalism, which can instil confidence in your business.
Some clients - large corporations and those in the financial sector especially - simply prefer to work exclusively with limited companies, but others flatly refuse to deal with unincorporated businesses. So, having a limited company can present new business opportunities that may not otherwise have existed.
Other advantages of a limited company include:
It's not that expensive or difficult
If you ask most people how you’d go about forming or setting up a limited company, chances are they’d stare back at you blankly. A common misconception is that incorporating is some kind of bureaucratic obstacle course that can take months and cost thousands of pounds. The truth, though, is that you can incorporate online in less than ten minutes, and all for about the cost of a takeaway pizza, or even for free!
Easier access to finance
The separate legal entity of a limited company may make it slightly easier to secure finance to help grow your business than sole traders. Also, companies 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.
Securing a trading name
Once you register a company with Companies House (or save yourself some money and use our Crunch Formations service), the company name is legally protected, which means there can only be one company in the UK with the same name (or anything too similar). The trouble is, as a sole trader, someone else can use your trading name and you’re powerless to stop them.
Worse still, if they’re into dodgy dealings (think Cowboy Builders and Rogue Traders) this could hurt your business no end and put you through the stress and inconvenience of having to change your trading name and potentially lose all the hard-earned brand recognition that you’ve built up over the years. Don't forget though, there some rules around naming your business - find out more about coming up with a great business name.
Protecting a trading name for a future business
Let’s say you’ve had a lightbulb moment - you've got an inspired idea and a name for a business, but you’ve neither the time nor the capital to develop it just yet. Instead of abandoning your idea altogether, you can set up a dormant company to put the business on hold and protect its trading name at the same time.
In the eyes of HMRC and Companies House, a dormant company is one that doesn’t trade and has made no significant accounting transactions during a financial year. You'll need to let them both know that your company is dormant and there's a few things you'll need to file each year, but setting up a dormant company can protect your future interests.
Easier to sell/transfer business ownership
If you want to call it a day, sell your shareholding or (heaven forbid) you go to meet your maker, it’s much easier to transfer ownership of a limited company than an unincorporated structure. Clients, equipment, the whole caboodle can be bagged up and sold off.
For sole traders, this can be problematic, as typically the equipment used is owned by them personally, and many elements of the business are tied to their specific identity.
It's not as hard as you might think!
As a limited company director, you'll have various director's responsibilities. You'll have to keep on top of your bookkeeping, pay your business and personal taxes and produce and file accounts and various other returns to HMRC and Companies House. It can all seem a bit offputting.
But at Crunch, it's our speciality. Our Limited Company Accounting packages are all you need to take care of things wrapped up in a great value monthly fee. They include our easy-to-use online accounting software, but more importantly, all the help, support, and advice you need to make running your business a breeze. We take care of all the tax filing and you focus on making your business a success.
Speak to one of our friendly advisors who can take you through the whole process. We'll set your company up for you, register you for all your taxes and help you every step of the way.
What are you waiting for?
If these advantages have piqued your interest somewhat, and you want to start a limited company as your business structure of choice, you can wrap up the entire process online in just a matter of hours (Companies House has a rapid-fire turnaround and approves most applications within three hours).
Even better, if you become a Crunch client we can take care of it all for you.
A limited company isn’t for everyone, but the advantages are attractive.
Want to know more? Read our article on setting up a limited company.
You’ll learn what taxes limited companies pay, what to do about business insurance, how to optimise your wage using salary and dividends and much, much more.