One of the first decisions that a new business owner must make is about how to choose the legal structure of 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 to any structure depending on your circumstances. We explain some of the potential pros and cons of owning and running a limited company to help you get started and make the right decision for you.

What is a limited company?

A limited company is a type of business which exists as a separate legal entity to its owners. This separation means that everything the company owns, owes, and earns, is totally separate from the personal assets of the business owners.

 
Limited liability literally means that any liabilities, such as debts, are limited rather than the people in the business being personally responsible for them. As a result there’s less risk to the people who own and run the company, and their personal assets are safe if the company fails.
 

Are there different types of limited companies?

Yes, there are different types of limited company in the UK, and their rules and requirements vary slightly. The four most common types are:

• Private companies limited by shares (the most common type)
• Private companies limited by guarantee
• Private unlimited companies
• Public limited companies

Who can form a limited company?

Whilst you can register a private limited company by yourself (a process known as incorporation), there are some restrictions on who can be a director.

Directors are responsible for the day-to-day running of a company, so they need to be capable of doing the job. They’re also not allowed to 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 some people form a limited company to limit risk to their personal assets, or because they find it helps them to be more tax efficient.

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.

 
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 showing the business’s finances which are then made available publicly. 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.

This can help the business seem more credible, and can also make the organisation look larger than it is.

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. If you make pension contributions through your limited company this can also be more tax efficient.

Protecting your business name as a company

Registering your business at Companies House stops the name being used by anyone else, which can be particularly useful to prevent copycats and protect your brand.

Raising capital

Without shares to sell, sole traders can find it more difficult to find investors. In a limited company, you can raise capital by selling parts of the business to investors. This will make them shareholders (literally someone that holds shares in the company), so they’ll earn a share of the company’s profits, which is paid out as dividends.

What are the disadvantages of running a limited company?

Whilst registering as a sole trader can be done online fairly quickly, setting up and running a limited company can be a bit more complicated.

Choosing a company name

You’ll need an official company name to register the business at Companies House, although this might require more thought than you think. It can’t be the same or similar to another company name which has already been registered, and must not contain offensive or abusive language.

It’s also worth thinking about the future of the business. If things change, is your company name still appropriate?

Setting everything up

Your new company will 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, as well as a company address or registered office 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 part of registering the company you’ll also need to create and allot shares to its shareholders.

Forming a company costs money

Companies House do charge to register a limited company whereas registering yourself as a sole trader is 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 Self Assessment tax returns but the tax reporting process for limited companies is a bit more complex.

You’ll need to submit annual accounts to Companies House, as well as a Company Tax Return to HMRC in order to pay Corporation Tax for the company, and then report any income you take from the company separately.

Record keeping for limited companies

All businesses, regardless of their structure, must keep excellent bookkeeping records, but limited companies do need to go a bit further.

For instance, when you pay dividends to shareholders you must record the decision as the minutes of a meeting, even if you are the only shareholder in your business! Our guide goes into more detail about your responsibilities as the owner of a limited company.

Your business records are available publicly

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 – especially if you’re running a side-hustle that your boss doesn’t know about!

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.

 
If you’re still not too sure whether operating as a limited company or a sole trader is best for you, we can help! Read our guide for a more detailed comparison, talk to the team by calling 020 3355 4047, or get an instant quote online.