I’m setting up a new business, and wanted to know whether I should start as sole trader and later, if the business is successful, switch to a limited company – or should I use a limited company from the start?
Alasdair Taylor's Answer
There are various factors that will affect your choice.
From a purely legal perspective, the biggest advantage of a limited company is that you would not usually be personally on the hook for liabilities that arise in the course of the business. There are exceptions to this rule, but it is nonetheless a big advantage. In some situations, notably if you seek finance from a bank, you may be asked to give a personal guarantee, defeating the point of limited liability.
Another big advantage is that, if you want to take on investors or partners, a limited company allows for a great deal of flexibility in both ownership and management through the use of shareholdings and directorships.
On the downside, there is more paperwork – and a little more cost – involved in running a limited company than there is in running your business as a sole trader. You will need to file accounts and an annual return each year with Companies House. You will also need to keep certain records, and generally ensure that you act in accordance with companies law and comply with the articles of association of the company.
Sometimes, the factor that determines the appropriate business structure is not liability, flexibility or paperwork, but taxation. Income that is earned by a sole trader is taxed differently from income that is earned by a company. Companies pay corporation tax whereas sole traders do not, but on the other hand companies can distribute profits through dividends, which in the UK are taxed at a lower rate than earned income. You should take advice from your accountant on the taxation question, as the balance of advantages and disadvantages will depend upon your particular circumstances.
Indeed, business structure is a crucial early question, and if you are in any doubt about the other points mentioned here, you should take professional advice on those too.