Limited company or sole trader? Which is the best company structure?4 Sep 2022
Limited Company vs Sole trader: What's the best business structure for a start up?
Choosing the most suitable and best business structure is one of the first and most important decisions facing small business owners when starting up.
There are four choices available: Sole Trader, Partnership, Private limited company (Ltd) and Limited Liability Partnership (LLP), and we’ll discuss some of the pros and cons here.
Legal risks of being a sole trader
Beinga sole trader is inexpensive to set up and means you can get to work right away, all decisions are yours and everything made (after tax) belongs to you. However, becoming a Sole Trader means there is no distinction between the assets of the business and its owner so, if the business fails, you are personally liable for any debts.
All business comes with risk but some businesses are more inherently high risk than others. It's essential to assess the level of risk when deciding what is the best structure for you.
Risks also include tax risks - a classic issue with sole traders is where, for one reason or another, the bsuienss owner does not keep proper accounts records, expenses as well as receipts ,thinks they can put off or not pay full tax or declare fully. The Inland Revenue will potentially bankrupt you if you owe tax money, don't believe this can't or won't happen.
Are your customers businesses or consumers?
If your customers are other businesses then you may benefit from the credibility and sense of professionalism that (for purely cosmetic reasons) a limited company provides. If your customers are consumers though, and you are under the VAT threshold (approx. £80k annual revenue), then this means that you are able to offer products and services without adding VAT and thus may well have a pricing advantage against your larger rivals.
Business Structure tax considerations - what is your expected annual turnover and profit?
Sole traders are self-employed and pay income tax on their earnings (less their tax deductible costs), at normal personal income tax levels. By incorporating, a small business owner is able to get their full tax free personal allowance (as if they were self-employed) as well as benefit from tax efficient dividend distributions from the company. It’s worth doing the calculations carefully, but in nearly all cases it is most tax efficient to become a limited company.
The right business structure for sale or exit
When it comes to retirement, if you expect to simply shut down then a sole trader structure might well sufficient, even if you have a few business assets to sell. However, if you expect to have assets and an ongoing business concern, a limited company or an LLP will allow you to sell the benefit of the customer contracts to a potential purchaser. In service businesses, this is effectively the entire value of your business.
Limited company structure best to raise funds from investors
Investors need shares, and so the only option if you intend to raise capital is a private limited company. If you are unlikely to be raising funds from investors then you can get started quickly as a Sole Trader. But even as a sole trader, you may still be able to secure personal or asset finance.
So what’s the difference between a Partnership and a Sole Trader?
Forming a Partnership is common in domestic and building trades. It’s often two people who know each other well and only require a simple business structure. As with a Sole Trader, the only legal requirement of a Partnership is that both partners register as self-employed and fill out a separate tax return. When forming a Partnership, agreements should be made on how profits, liabilities and ownership are split and what happens if one partner wants to leave; this is called the Partnership agreement. But like a Sole Trader, personal assets are not protected.For advice on setting up a business generally, accounts, financial planning or reports or business plans, get in touch with us and our sole trader accountants. Browse our full range of accounting services here and see how we could help your business today.