The Pros and Cons of Being a Limited Company

If you run a small business you may currently function as a sole trader – this can be a great way to work and can be very effective for many people. However, there is another: operating as a limited company.

If you run a small business you may currently function as a sole trader – this can be a great way to work and can be very effective for many people. However, there is another: operating as a limited company.

“Most entrepreneurs who go into business this way work as sole traders for the sake of simplicity,” says Darren Fell. “After a while many freelancers decide to form a limited company for their business though, either out of personal preference or on the advice of their accountant.”

But this is not necessarily the ideal choice for everyone; starting a limited company can be complex and create a number of issues that you will need to deal with. Of course, it also comes with benefits such as a more favourable tax situation and a more professional appearance. Working as a limited company is becoming increasingly popular – there are now 4.2 million limited companies in the UK, up from 2.6 million in 2010.

In this article we will take a look at the pros and cons of setting up a limited company rather than being a sole trader. This will allow us to look at whether you would benefit from doing so and if this is the right choice for you.

The Advantages

Becoming a limited company can be hugely beneficial for a number of reasons. Some of the major positives include:

  • Tax efficiency – the first major reason to become a limited company instead of a sole trader is the tax benefits. As the director of the limited company you would usually take the maximum tax-free income up to your personal allowance of £12,500 as salary (as of 2020), and then take the rest of your income in the form of dividends. This can be extremely beneficial as there is no National Insurance Contribution to pay on dividends. It is worth noting that limited companies do pay corporation tax of 19% on profits; this is lower than the 20-45% tax you would pay as income tax as a sole trader.
  • Limiting your liability – another important reason that you might choose to become a limited company is due to the fact that you won’t be liable for the business, as you would as a sole trader. In practice, this means that if the business incurs debts, your personal finances and assets are protected.
  • The business is its own entity – whereas a sole trader must be responsible for entering into contracts and having liability for business actions, the limited company is a separate legal entity, which can be hugely beneficial and allow much greater flexibility.
  • A more professional look – operating as a limited company, even if you are only one individual involved, makes your business appear larger and more professional. This might not seem like it would be important, but it can genuinely make a difference to how other businesses and customers perceive you. It can even get you considered for jobs that may not have come your way as a sole trader.

if the business incurs debts, your personal finances and assets are protected.

The Disadvantages

Just as there are pros and cons with being a sole trader, there are negatives that come with being a limited company too. Some of the major disadvantages include:

  • A more complicated setup – becoming a limited company can, of course, come with a huge range of benefits, but it is quite complicated to setup. A sole trader has a fairly easy time of this; simply registering with HMRC. Starting as a limited company means registering with Companies House and paying a fee to do so. This process can be daunting if you are doing it for the first time.
  • Complex accounts – managing the accounts of a limited company comes with a range of additional challenges you won’t face as a sole trader. Small business accounts specialists PKB state that some of the accounts issues that limited companies need to deal with include payroll, bookkeeping, and tax planning – not to mention tax returns, business expenses, and keeping company accounts up to date. Additionally, failing to fill in tax returns correctly can result in fines and other punishments. “Picking the wrong structure could see you paying more tax than is necessary,” says Daniel Mepham, “it is important to identify early on if the wrong structure is being used so a plan can be put in place to change to something more suitable”.
  • Issues with ownership – as a sole trader you make all of the decisions and only need to justify them to yourself. As a limited company it is not quite so simple, as you may have shareholders. These shareholders will be able to have a say in how the business is run and will need to be appeased. This can complicate matters significantly.
  • Less privacy – as your business will be registered with Companies House you will share information about your company directors, as well as shareholders and accounts. These records are then available to anyone who wants to access them.

Final thoughts

There is no ‘right’ answer here – it all depends on your circumstances. It’s a great idea to take independent advice from specialists in order to establish whether running a limited company is going to be the best solution for you.

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