What is the difference between a sole trader business and a limited company?
Starting your business is not an easy task. A multitude of questions springs to mind: what kind of business should I start? What administrative documents should I complete? Which legal structure suits my business? Do I need to pay taxes?…
Today, the question ThisForeignerCan will address is that regarding the legal structure, and in particular the difference between a sole trader and a limited company.
I- Sole trader Business
A sole trader is a type of business which is run and owned by an individual. This means that there is no clear distinction between the business and the owner. In other words, the owner is responsible for both his personal and business finances. Working as a sole trader doesn’t necessarily mean working alone; you have the possibility to hire staff if you wish.
There are reasons why several entrepreneurs choose to start their business as a sole trader. We can summarise these reasons in 3 words: flexibility, profit and ease.
Having this business will give you more flexibility: the fact that you are alone will allow you to take your own decisions and to adapt your business to any changes as quickly as possible. With this legal structure you do not have to share your profit with shareholders, as we said before – you are alone and the profit that your business earns is yours. Concerning the administration papers and the registration, the sole trader business is the easiest legal structure you can find – the only thing that you have to do is register your self-employed status with HMRC every year.
Nevertheless, the sole trader business structure is not perfect and there are some disadvantages. The liability is the first negative point. As we said before, business and owner are one. Consequently, the owner is liable for the company debts. The second disadvantage is financial: it can be difficult to raise funds alone and, unfortunately, it’s difficult for a company to start without funding.
II- Limited Company
The limited company is an independent entity where owners are legally responsible in accordance with their financial contributions. Contrary to the sole trader business, this structure has its own legal entity. To put it more simply, individual and personal finances are distinct. There are 4 different forms of Limited companies: the ownership, the limited by shares, the private company limited by guarantee and finally the public limited company.
As with the sole trader company model, the limited company structure also has it pros and cons.
Thanks to the shareholder with a limited company your investment capacities are numerous. In addition, your company growth potential is strong. You may have more credibility thanks to your company name, for example. In a limited company you are not alone and when you make a decision all the shareholders have to give their prior consentment. Consequently, everybody gives their opinion, and this allows your strategy to be more complete. This last point can be a disadvantage because your power in the company will depend on your capital contribution. The other negative point is to do with administration: you have to complete a lot of administrative paperwork like the annual accounts, corporation tax returns, VAT returns…
III- What is the difference between them?
As we said previously, the main opposition between these two entities concerns liability. The sole trader business does not have its own legal identity: there is no distinction between the owner and his business, your personal assets are not protected. For instance if your business has a lot of debt, you will be personally responsible. In case of default payment, your house can be taken.
Contrary to the sole trader business, the limited company has a limited liability. In other words your business has it own legal entity, you have the possibility to separate your own assets from your business assets. If your business is in trouble you are not liable and your own assets will be safe.
The other difference that you can find between these two businesses concerns the accounting. The accounting rules for a limited company are more complex than the sole trader business. With the limited company structure you have to prepare annual accounts at the end of every Financial Year. This requires an accountant and therefore will be another cost for your company. As regards the sole trader business, all that is required is business expenses and personal income. Using an accountant is not an obligation.