One of the first decisions that a new business owner must make is about how to operate their business. Do you want to be a sole trader? Would it be better to start a limited company? There are good and bad points with either, depending on your circumstances. We explain the pros and cons of owning and running a limited company to help you get started.
What is a limited company?
A private limited company is a type of business which exists as a separate legal entity to its owners. Everything that the company owns, owes and earns is totally separate from the personal assets of the business owners.
It’s called a limited company because liability is limited.
Limited liability literally means that any liabilities, such as debts, are limited. This means there’s less risk to the people who own and run the company, and that their personal assets are safe if the company fails.
Who can form a limited company?
Whilst you can incorporate (register) a private limited company by yourself, there are some restrictions on who can be a director or company secretary. A company director is the person responsible for running the business.
You must not be:
An un-discharged bankrupt
Disqualified from being a director
15 or younger
What are the advantages of setting up a limited company?
Every business is different, but you might decide to form a company to be more tax efficient, or to limit risk to your personal assets.
Limited liability in a limited company
Whilst sole traders aren’t legally separate from their business, the owner of a limited company is. This means that the responsibility for any liabilities (such as paying debts) stays in the company. It ensures that the directors and shareholders aren’t personally liable for any liabilities.
This legal separation between companies and their owners also means that the company continues to exist beyond its members. For instance, if the owner(s) of the limited company should die, the company will still exist until formally wound up. This provides extra security for any employees and other remaining directors and shareholders.
Your company might have more credibility
Limited companies are subject to more scrutiny, such as registering with Companies House and submitting regular accounts which are available publicly. This can help the business seem more credible, and can also make the organisation look larger than it is.
Being able to check out the business in this way means that some suppliers and customers prefer to deal exclusively with limited companies. In that respect, incorporation might actually help you win more business.
Better tax efficiency and planning
Depending on how much money the business makes, you might find that it’s more tax efficient to operate as a limited company than as a sole trader. This is because of the differences in how sole traders pay tax and National Insurance, compared to taxation for a company and its directors and shareholders. Pension contributions made through your limited company can also be more tax efficient.
What are the disadvantages of running a limited company?
Whilst registering as a sole trader can be done online fairly quickly, setting up a limited company is a bit more complicated and there’s a cost for registering.
You’ll need a company name, which might require more thought than you might think, as it could affect the company at a later date. The name must not be the same or similar to another company name, and must not contain offensive or abusive language. Your next stop is to register it with Companies House.
You’ll also need to produce a Memorandum of Association as well as Articles of Association. These documents explain who runs the company, and can be particularly useful in the event of any future disagreements.
You must supply the details of all company directors, such as their name, address, nationality, and date of birth. You’ll also need to supply a company address, along with a registered address if this is different. The details will be available through Companies House once you register, so other people will be able to look up this information.
As well as registering the company, you’ll also need to complete an SH01 form to allot shares to shareholders.
Companies House do charge to register as a limited company, whereas registering yourself as a sole trader is it’s free. Whilst the cost might not be huge, the process of gathering all of the information can be time consuming! Learn more about our free limited company registration service.
Dealing with tax and accounts
Sole traders usually deal with tax by submitting a Self Assessment tax return. The tax reporting process for limited companies is a bit more complex. It involves submitting annual accounts to Companies House, as well as a Company Tax Return to HMRC in order to pay Corporation Tax.
While sole traders and limited companies both need to maintain accurate records, a sole trader can keep theirs confidential. Limited companies submit company accounts, which are available for public viewing through the Companies House website.
Some people may feel reluctant to share information about how well the business is performing. This is certainly something to consider when choosing a legal structure for your business. The details of the company directors are also public, which some people might be uncomfortable with.
Opening a business bank account
Limited companies must have a bank account in their own right. It’s good practice to use a separate bank account for your business though, no matter what type of structure you choose.
Is a limited company the right business structure for you?