The two most common business structures in the UK are Limited Company and Sole Trader (also known as self employed). Choosing the right business structure is incredibly important. In some situations making the wrong choice can cost you greatly.
Learn the difference between the two structures, and find out if you should run your business as self employed or a limited company.
To put it simply: if you trade with the intention of making a profit, and you haven’t set up a company, you’re a sole trader, or self employed. As a sole trader, you are the business, and the business is you. All the money you make from trading will be considered yours, and you have to pay normal income tax.
As a sole trader, you own 100% of the business. You cannot sell or give away shares to investors. It’s also worth noting that you are at risk if anything goes wrong. If a customer sues you, they will sue you as a person, and not just the business. You’re personally liable for any damages or accidents, which could lead to insolvency. We highly recommend that all sole traders get proper insurance to minimise this risk.
Like a sole trader, a limited company is easy to set up, however you have a lot more options in terms of the structure and ownership of the business. The main difference is that while as a sole trader you ARE your business, a limited company is formed as a separate legal entity.
A limited company has one or more directors (managers) and shareholders (owners). The directors and shareholders can be the same people, but you can also have shareholders who own a percentage of the business without having any interest in the day-to-day running of the business, like silent investors.
Since the business is a separate legal entity, the money you make for the business will not automatically belong to you. You will need a separate business bank account, which you cannot use for personal purchases. You will have to pay yourself a salary and/or dividends from the company, which will make up your personal income.
Limited companies are also subject to a higher degree of complexity and increased red tape, where they have to provide financial statements which become public record, and pay separate business taxes. Although we always recommend any business of any size to work closely with an accountant, this is particularly important for limited companies because of their more complex compliance needs.
Limited Company vs Self Employed – Which do you choose?
If you’re an individual starting a small business, doing odd jobs and trying to build a stable income by trading on your own, it might be easy to start out as self employed. You can change to a limited company later if your business grows or your needs change.
If you start a business with a high growth potential, or you need investors to help you get the business started, you should set up a limited company straight away. Read more about EiS and how to get investors.
Here are some signs that you might want to incorporate and set up a limited company:
- You want several owners in the business, such as shared ownership with a co-manager, or giving shares to investors to raise investment capital. See other ways to raise capital to start a business.
- You invest in expensive equipment
- You have several employees
- You want less personal risk for any reason
- You have a substantial income and want to save money on tax
- You want to grow a business independent of you so you can sell it for a higher amount later on, for example when you retire
- You want to apply for certain tax credits or government grants, like R&D tax credits
If you’re not sure which business structure works for you, I highly recommend that you talk to a trusted accountant or business adviser, as they will be able to give you a more personalised recommendation.