What’s the difference between a sole trader and a limited company? Check out our definitions, compare the advantages and disadvantages, and find out which legal structure best suits your business.
Every business, no matter how big or small, needs a legal structure. You can choose to be either a sole trader, a partnership, or a limited company.
Most businesses choose to be either a sole trader or a limited company, so we’ve put a guide together answering the key questions on these two business types:
- sole trader or limited company: what’s the difference?
- what is a sole trader?
- what is a limited company?
- should I be a sole trader or a limited company?
- can I change from being a sole trader to a limited company?
Sole trader or limited company: what’s the difference?
Whether you choose to set up as a limited company or sole trader, this is officially the legal structure of your business.The main differences between the two involve tax rates (as well as how you pay tax) and how much liability you have over your business – including debts and assets.
Sole traders are generally self-employed business owners, whereas a limited company could have any number of employees. While setting up as a sole trader is easier than starting a limited company, it may not be the right fit for your business.
According to the Department for Business, Innovation and Skills, at the start of 2023 there were 3.1 million sole proprietorships (56 per cent of the total), 2.1 million actively trading companies (37 per cent), and 365,000 ordinary partnerships (seven per cent). Keep reading to learn which is the right fit for your business.
What is a sole trader?
A sole trader is essentially a self-employed person who’s the sole owner of their business. It’s the simplest business structure out there – which is probably why it’s the most popular – and you can set up as one via the gov.uk website (you’ll need to do this for tax purposes).
Read our guide on how to register as self-employed with HMRC.
What is a limited company?
A limited company is a type of business structure that has its own legal identity, separate from its owners (shareholders) and its managers (directors). This remains the case even if it’s run by just one person, acting as shareholder and director.
Sole trader vs limited company
Ultimately, you need to weigh up the difference between a sole trader and limited company, as the structure you choose could impact everything from your profits to paperwork.
Should I be a sole trader or a limited company?
Don’t rush into any decision and speak to an accountant if you’re unsure, as their expertise is often invaluable when it comes to tax.
Elsewhere, investigate insurance – regardless of the structure you choose – as running any type of business will bring its own unique risks. Discover more on sole trader insurance and limited company insurance and find out a basic overview of what you’ll need.
Sole trader advantages
- easy to set up and relatively little paperwork, other than an annual Self Assessment tax return
- greater privacy than incorporated businesses, whose details can be found via Companies House
Sole trader disadvantages
- sole traders have unlimited liability, which means there’s no legal difference between themselves and their business – so if the business gets into debt, the business owner is personally liable
- this means that sole traders can lose personal assets if things go wrong
- raising finance can be tricky, as banks and other investors tend to prefer limited companies. This limits the expansion opportunities of sole traders
- tax rates on sole traders aren’t always as kind as they are on limited companies. When you reach a certain level of earnings, it might not be quite as lucrative to remain a sole trader
Limited company advantages
- unlike sole traders, a limited company is legally separate from its business owner, who has limited liability
- this means personal assets aren’t exposed – you only stand to lose what you put into the company
- once you’ve registered a company name, nobody else can use it. In contrast to sole traders, who aren’t offered the same protection
Plus, broadly speaking, limited companies stand to be more tax efficient than sole traders, as rather than paying income tax, they pay corporation tax on their profits.
As things stand, this offers a kinder tax rate than the higher rates of income tax, meaning forming a limited company can be more profitable. In addition to this, there’s a wider range of allowances and tax-deductible costs that a limited company can claim against its profits.
Limited company disadvantages
- limited companies have more responsibilities. These are known as the director’s fiduciary responsibilities, which basically outline what a limited company director must do legally
- thanks to these added responsibilities, going limited can be costly and time-consuming, as you’ll need to either deal with this extra paperwork yourself or hire an accountant
- information about your business can be found via Companies House, meaning details on directors and your company’s earnings are required to be shown publicly. This sort of transparency may not appeal to all
Some of the added responsibilities include filing an annual company tax return, as well as annual accounts.
You’ll need to pay a fee to incorporate too – check out our guide to setting up a limited company to learn more.
Can I change from being a sole trader to a limited company?
If your business circumstances change and you decide that being a limited company is a better fit for you, you can change from being a sole trader to a limited company.
While it’s always good to speak with an accountant or someone who knows your business well, here’s a rough outline of the steps you need to take.
- Form a limited company – choose a name to trademark that isn’t already in use (our business name generator can help here).
- Choose your leadership team – this can be directors, shareholders, guarantors, or anyone that will have a control of your business.
- Register as a limited company – check the government website to see which forms you’ll need to complete and which records you’ll need to prepare.
- Register for Corporation Tax and with Companies House – you’ll need an official business address for this step.
- Tell HMRC you’re no longer a sole trader – they’ll need to deregister you from their records.
- Update your insurance provider – any changes to your business could affect your cover.
Are you deciding whether to stay self-employed or go limited? Let us know in the comments.
Guides and resources for small businesses
- Going self-employed in the UK: a guide to get started
- What can you claim as self-employed tax deductible expenses?
- The best business bank accounts in the UK compared
- How to do a VAT return – step-by-step
- Is public liability insurance tax deductible?
Ready to set up your cover?
As one of the UK’s biggest business insurance providers, we specialise in public liability insurance and protect more trades than anybody else. Why not take a look now and build a quick, tailored quote?
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