Sole trader or limited company - which is best for you?
One of the first decisions you have to make as a freelancer is what business structure to use. For most freelancers, this boils down to deciding whether to operate as a sole trader or to set up a limited company. But what’s the difference between these structures and which one is right for you?
What is a sole trader?
A sole trader is someone who is self-employed and the sole owner of their business. In other words, if you’re a sole trader, you’ve got complete control (and complete responsibility) for all aspects of your business, from the services you offer to how you manage your finances.
A sole trader is the simplest type of business structure to set up - all you need to do is tell HMRC that you’re self-employed and will pay tax through the self-assessment process. In fact, unless you specifically choose a different structure, you automatically become a sole trader when you register with HMRC as self-employed.
There is also limited regulation and paperwork involved in running your business as a sole trader. While you must keep accurate records of your finances, sole traders don’t need to submit annual company returns or separate business tax returns. Instead, you include details of your sole trader business in the self-employment pages of your personal tax return. Once you’ve paid tax and National Insurance, you can keep any profits that the business makes. You can even take on employees as a sole trader, as long as you register with HMRC as an employer.
If this sounds too good to be true, there is one major point to bear in mind. What makes a sole trader distinct from other types of business structures is that, as a sole trader, you and your business are regarded as one legal entity - and this has some potential drawbacks. For starters, it can make it more difficult to access business loans and support. Most significantly however, it means you’re personally responsible for any liabilities of the business. In other words, if your business builds up debts, you could legally be required to use personal assets, such as your own home or personal savings, to pay off those debts.
What is a limited company?
The other main route that freelancers go down is to set up a private limited company with shares. This means that your freelance business is a separate legal entity from you as an individual and has separate finances. If you want to retain full control and responsibility for your business, you can issue 100% of the shares in your company to yourself. However, unlike a sole trader business which must only ever have one owner, it’s possible to have multiple shareholders for a limited company.
The big upside of this structure is that you’re not personally liable for any financial losses that the company makes (assuming you’re operating it legally and have not committed fraud, of course!) In addition, even if you’re the only person in your company, potential clients may consider you to be bigger and more credible than a sole trader when you put forward pitches as a limited company. Similarly, it can be more straightforward to take out business loans through a limited company than as an individual sole trader.
The downside to this structure is that there is more paperwork and regulation involved in setting and operating up a limited company. For example, you need to register the company, appoint at least one company director (which could be you), issue shares, submit an annual confirmation statement about your company and submit an annual tax return for the company, in addition to your own personal tax return - all of which can incur additional costs such as accountancy fees.
You also need to work out how you’ll be paid. Unlike a sole trader, the company profits are not automatically yours personally, as they belong to the company. Instead, you can either pay yourself a wage as a company employee or take dividends from the end-of-year profits - or a blend of both. One final point to note if you can down this route is that some of your details including your business address and your name (as a company director) will be publicly available via Companies House.
Which is better for you?
The structure which is right for you will largely depend on your specific circumstances. If you don’t need investment and are unlikely to rack up debts or liabilities, the simplicity of the sole trader structure may appeal. On the other hand, if you’re targeting big companies and/or want to take on business loans, setting up a limited company may be a better option.
Many freelancers start off as sole traders and then set up a limited company as their business grows. However, others choose to set up a limited company from day one while others still operate extremely successfully as sole traders throughout their freelancing careers.
If you’re unsure which path to go down, do seek professional advice. Ultimately, however, you can choose which structure is best for you - it’s your freelancing business, after all!
Next steps
Take a peek at our guide: How to Set up as a Sole Trader for practical information and tips about setting up as a sole trader.
Related Articles
