One of the first questions I often hear new freelancers and small business owners ask is if they should go limited company or not? A lot of people will claim it’s “safer” to go limited, as if things go wrong, your personal finances are protected against claims, etc, but is that really the case? And is that the best approach to take for your business?

In this blog, I want to talk through the key differences between being a sole trader vs setting up as a limited company and what you need to consider when deciding on the best model for your business. Please remember that I’m not an accountant and this is just information I’ve learned over the years I’ve been in business when I’ve been reviewing my strategy each year. You should always consult a financial expert before making important decisions like this.

What does being a sole trader involve?

As a sole trader, you are the only owner of your business and are responsible for all finances related to it. That means any profits you make are automatically yours but you’re also personally responsible for any losses you make. There’s actually no legal difference between business money and your personal money when you’re a sole trader, so any profits you hold in your business account will be classed as personal income by the DWP, HMRC, etc.Picture of the words limited liability company on post-its

Setting up as a sole trader is easy to do, and due to recent HMRC changes you no longer need to register with them until you’ve earned more than £1000 in a financial year (6th April to 5th April). You then contact HMRC and state you wish to register as a sole trader and they set you up for self-assessment. This gives you some breathing space to test out your business idea before registering and having to deal with things like self-assessment, just keep an eye on your income and register when you get close to that £1000.

Currently, self-assessment is yearly (this will change in the future with the Making Tax Digital strategy) and must be completed by the 31st January each year and any tax owed paid by this date too – I’d advise you to complete your self-assessment as soon as you can after the tax year ends (5th April) so you know what you need to pay and have longer to do so!

As a sole trader, you can trade under your name or any business name but this also means other people can trade with the same name as you if they are also sole traders. If you think you may want to change to a limited company in the future, do check the limited companies register for that name as your company name can only be used by you in that instance.

You can operate your business as a sole trader completely privately and don’t need to share this information on a public register. However, if any claims are made against you by clients or third parties, you are personally responsible and may lose your assets (including your home) but having the right insurance, contracts and processes in place will heavily mitigate this risk.

What does limited company really mean?

A limited company is a distinct legal entity from you as a business owner, you technically work for your business as a director and are paid a wage/dividend. You’re still responsible for all the key business and financial decisions but any profits and losses belong to the company rather than you personally.

You have to be over 16, haven’t been prohibited by a court order from being a company director and have no history of bankruptcy to set up a limited company. Most small business owners set up as a private limited company (here’s a good link explaining the differences) and need to have a unique company name (can be checked at Companies House). An application with Companies House is then made which currently costs £12. Once this has gone through, no one else can use your business name.

You can go through the process of registering with Companies House as a limited company by yourself, or through an agent such as an accountant. I personally think going through things with an accountant is important as by registering as a private limited company you’re also registering for Corporation Tax which must be in place in the first three months of your company registration. Many will guide you through registering yourself rather than charging you a hefty fee for them to do it, so do check this is an option. Once your business is fully registered, you’ll receive a ‘Certificate of Incorporation’ with your company details.

As a limited company director, you are responsible for paying Corporation Tax on the profits your company holds but you’re also responsible for paying self-assessment tax on the money you’ve earned through the company as a director under PAYE and paid out through dividends. Corporation Tax is handled very differently to self-assessment, so an accountant is crucial. It’s too much to go into for this blog, but here’s a nifty link covering the basics.

As a limited company director, your name and business appear on a public register along with your year-end tax report. This means anyone can search for your information as it’s in the public domain. You’re legally required to adhere to the Director’s Fiduciary Responsibilities which are a code of conduct appropriate to being a director rather than an employee. If any claims are made against the company, however, you aren’t personally responsible for them and the business may be liquidated if the losses can’t be accounted for from the business bank account and assets.

Which is the best business type?

As you can see, there is a lot of additional work and responsibility required in setting up as a limited company. Yes, there are some additional protections for you as an individual but with the right mitigations in place from the start of your business (insurance, contracts, the scope of work, etc) I’m not personally sure going limited for that reason is worth the additional workload and expense.

You can change from sole trader to limited company at any time, so I believe it’s better to wait until your business is established and you’re turning over a high enough profit for the Corporation Tax to work out better for you than self-assessment. Only an accountant can really advise when this is the best time for you.

If you do have several employees you’re paying under PAYE, are dealing with VAT returns, importing/exporting or working with large public organisations who prefer working with limited companies then you might be better off going limited company but again this would be once your business is established and for many small business owners would take years rather than months to reach that point.

These are just my own personal thoughts after much research into the right business model for Banks’ Business Solutions. Whatever you decide for your own business, don’t rush your decision, get some free consultations with several accountants to get the best advice possible, and be fully aware of what you’re taking on before your commit.