It is an important decision to make as the formation of your business (yes, even as a freelancer or contractor, you are considered a business) will have a financial and legal impact on your future.
What is a sole trader in business?
The hint is the name - ‘sole’ - meaning a single business owner or using a more common name - ‘self employed’.
Historically ‘sole traders’ were associated with manual professions but in fact anyone can form this type of business. It is also the easiest business type to set up. You just need to register with HMRC for self-assessment. An easy online process these days that takes no time at all. You can trade under your own name or pick a business name.
You have to register by 5 October of your second tax year but for the sake of order and clarity, you really should register before you start trading.
If you decide to go the sole trader route, your earnings will be subject to income tax and national insurance, very much the same as if you were an employee. However, the difference is that while employees have taxes deducted from their wages periodically, you’ll be only asked to pay tax after you have submitted your self-assessment tax form to HMRC. The online deadline is 31 January each year.
The one very important aspect of running a business as sole trader is that you are personally liable for any business debts, legal claims against the business lawsuits, and that remains the case even if you go bankrupt.
Can a sole trader have employees?
The common misconception is that to have employees, business owners need a limited company. That is not the case. Just like any other business formation, sole traders can employ other people.
Note that as a sole trader, you cannot be an employee of your own business. You will always be classed as self employed.
The next question that often comes after is: How many employees can a sole trader have?
There is no limit on how many employees you can have as a sole trader. However, if you are taking on a lot of staff, it probably means that your business is rapidly expanding. With that your liabilities will be on the rise too and it may be time to consider a different business formation.
What is the advantage of being a sole trader?
- It’s uncomplicated and quick to get started
- Very little paperwork is required
- Easy to change in the future to a partnership or a limited company
What are the disadvantages of being a sole trader?
- It could be less tax-efficient than a limited company
- You are personally liable
What is a private limited company in business?
Private limited company in the UK means that the business you have set up is a separate legal entity from you. As a result, while you still have responsibilities as the shareholder and a director (if you appoint yourself as one), you are not personally liable.
The most appropriate type of a limited company for a commercial business (not a charity or non-profit organisation) is a company limited by shares. As an owner of a limited company you will hold shares in your company. If you have business partners, you will each hold a number of shares in the company.
Owners of a limited company can pay themselves in a number of ways. You can take a salary as an employee, you can pay yourself in dividends from the company profits or a combination of both.
Setting up a limited company is not as complicated as budding business owners think. Incorporating a business can be done online with the Companies House and completed in 20 minutes or so as long as you have all the information to hand and are happy to accept the standard articles of association (the rules about running the company). If you have investors or business partners, you may need to take advice on the most appropriate version of articles of association.
Limited company owners have the responsibility to register for and pay corporation tax. This is a tax on the company profits. If you decide to pay yourself an employee wage, you will need to pay income tax on your salary as well as on any dividends that you take out of the company. You are likely to benefit from the advice of a qualified accountant.
An accountant will also keep an eye on your other responsibilities as a limited company owner such as submitting annual accounts and other required information about your company to Companies House each year.
What are the advantages of a private limited company?
- Can be very tax-efficient
- Your personal liability for business debts or legal claims is limited
- Often seen as a more serious business type
What are the disadvantages of a private limited company?
- Due to the more complex nature of running a limited, you are likely to need an accountant
- There is more paperwork involved in running a limited company
- Your personal details will be published on Companies House website
- Bringing a partner in the business requires structural changes to the company
- There is a cost to closing a limited company
What is right for you?
As a new business owner facing having to make this choice, you are most likely to be focusing on the cost effectiveness and simplicity.
Both are important but the personal liability is also a significant consideration. As a sole trader you can take certain steps to protect yourself against this risk. Always make sure you have a written contract with your customers which limits your liability and make sure you have suitable insurance for your profession.
However, if your targeted clientele consists of large businesses and corporations, you may need to go the limited company route from the start. One reason is that businesses of a certain size don’t tend to deal with sole traders and secondly, the bigger the client, the deeper the pockets. If something were to go wrong while working for one of these clients, just the legal costs to defend yourself could quickly tip your personal bank balance in the red.
In summary it comes down to what is more important to you. Do you prefer the simple and flexible structure of a sole trader, or the more tax efficient and less risky limited company business?