If you’re considering starting a business one issue you’ll be faced with is the choice of legal entity your business is to adopt.

Let’s assume for a second you’re not going to enter a partnership. What you’re left to choose from is either to trade as a sole trader or as a limited company.

The correct choice depends on a number of factors we discuss throughout this blog post.

The aim of this post is to aid budding entrepreneurs in making this important decision correctly, the consequences of which could be felt both now and well into the future.

Some industry’s look down on sole traders. If you sell ‘business to business’ your customers may wish to see your accounts. If you’re a sole trader your customers cannot legally compel you to reveal your accounts. Limited companies on the other hand are required to submit year-end accounts to Companies House each year. This lack of transparency inherent from trading as a sole trader may mean your supplies refuse to throw you a line of credit. In turn your decision to trade as a sole trader may damage your cash flow.

#2. Consider enhanced compliance obligations as a result of trading as a limited company

Trading as a limited company creates an excess of paperwork most new entrepreneurs really do not appreciate. For instance if you trade as a sole trader there’s no obligation to file year-end accounts and an ‘annual return’ to Companies House each year. Sole traders complete a tax return and do not need to file a separate corporate tax return. Limited companies are still required to file the tax return to HMRC too on behalf of each registered director.

Limited companies employing staff must register with HMRC as an employer and seek payroll services.

#3. Understand the concept of ‘unlimited’ and ‘limited’ liability

If you choose to trade as a limited company your liability is limited to capital you invested in shares. If your limited company enters liquidation your creditors do not have a claim over your personal assets as a means of repaying debts owed. This is because a limited company is considered a separate legal entity to those who run it. Creditors are only permitted a claim over directors’ personal assets if a claim for wrongful or fraudulent trading is successful at court.

Limited liability is not afforded if you choose to trade as sole traders. Sole traders are not treated as divorced from their businesses. This means if you become bankrupt as a result of your trading activities your creditors are at will to make claims against your personal assets, including your home and vehicle.

#4. How important is privacy?

If you trade as a limited company your personal details are available on public websites such as Endole and DueDil. If you trade as a sole trader you keep your privacy intact. The address listed on public websites is the address of your registered office, not your home address. However many small businesses do list their home address as their registered office address.

#5. Do you plan to sell your business in the future?

If you plan an ‘exit strategy’ then we recommend you trade as a limited company. Selling intangible goodwill in the form of a sole tradership is much more difficult than selling tangible shares in a limited company.

#6. What if your profits are below the basic tax rate threshold?

The basic tax rate during 2015/2016 is £10,600. Those earning a profit less than this figure pay no tax whatsoever. This is due to your personal allowance. If you trade as a limited company you must still pay corporation tax even if you earn less than £10,600. Therefore if you plan to earn less than £10,600 in profit (not revenue) it may make sense to trade as a sole trader, at least until you begin to earn more profits.

Limited companies currently pay 20% on profits earned during 2015/2016. Directors’ salary or dividend payment is a legitimate tax deduction and limited companies do not have to pay Class 4 National Insurance contributions until certain thresholds are met.

#7. Factor in accountancy fees

Limited companies require their books to be ‘signed off’ by an accountant. This is not the case when you choose to trade as a sole trader. Accountancy fees may wipe out tax savings achieved as a result of trading as a limited company.

#8. Do you seek outside investment?

If you seek angel or ‘seed’ investment from outside sources then we recommend you opt to trade as a limited company. In return for their capital, investors expect equity shares in your business. Shares allow invests the ability to cash in on their shares at an inflated price later on.

#9. Trading as a sole trader could reduce your tax bill for other streams of income

If you make a loss in your business you are permitted to offset losses against other streams of income when you trade as a sole trader. Other streams of income could include dividend payments, interest on savings or rent paid by your tenant. If you trade as a limited company you are not permitted to offset business losses against other forms of income.

Contact The Financial Management Centre Today

If you require assistance with your business’s financial affairs call The Financial Management Centre on 0800 470 4820. Click here to find your nearest office or complete the enquiry form.

Tom Cowley
Tom Cowley

Tom brings a wealth of experience to The Financial Management Centre having started his working career as an accounts trainee working his way up to site number one over 20 years ago. He has extensive experience of working in the UK and overseas for a number of prominent groups including Unilever, Shell, Costain, Smit International, Arcelor Mittal and Columbus McKinnon.