There are two main ways in which a business can trade:
- On a self-employed basis. You will be a sole trader carrying on business in your own name or, if there is more than one of you, you may be in business in partnership with others; or
- Through an incorporated company registered with Companies House.
Many new businesses begin life as a sole trader but as the business grows over time and becomes more successful many business owners decide to turn their business into an incorporated company.
What is a limited company?
A limited company is registered with Companies House. Legally, a limited company is a separate legal entity to you. It is run by its directors and is owned by its shareholders, who are often the same people. Certain information has to be filed with Companies House such as the names of the directors and shareholders and its annual accounts. This information is therefore available for public view.
By contrast, a sole trader or those in a partnership are self-employed and they are the business. There is no separate business entity when you are a sole trader or are operating in a partnership.
The main difference between a limited company and other business structures is the concept of ‘limited liability’. This is why they are called ‘limited companies’. This means that the shareholders are only liable for the debts of the company to the value of their investment; they are not responsible for the debts of the company beyond this investment. Because of this, trading through a limited company is a popular choice.
Limited company or a sole trader/partnership?
So, what are the pros and cons of a limited company?
- The shareholders’ liability for the company’s debts are limited to the value of their investment. A sole trader/partner is personally responsible for all their business debts and will have to use their own funds if necessary to pay these debts;
- Your business can appear more professional a set up than operating as a sole trader. This might open doors for you to trade with other bigger companies on more profitable and larger contracts;
- There can be tax advantages to paying yourself through a dividend than a salary paying income tax;
- It can be easier to sell a limited company when you retire as the limited company is a valuable entity in its own right.
- Information about the company is available for public view. No information about a sole trader/partnership is made available for public view;
- Decisions made by the directors have to be minuted and recorded. There is no obligation for sole trader/partners to do so mean that decision making can be more flexible;
- Banks and finance companies might still ask the directors to give personal guarantees for borrowing by the company;
- There are annual administration costs payable for filing information with Companies House
If you are already a sole trader thinking about turning your business into a limited company or are just starting out and wondering whether to begin your business as a limited company it is worth discussing the tax implications with your accountant first.