If you work for yourself you are “self employed”. A self employed person working on their own can operate as a sole trader or a one person limited company.
It’s worth noting that there are other types of business structure such as partnerships, limited liability partnerships, community interest companies, charities and so on. However the main two types of business structure used by the vast majority of self employed people are sole trader or limited company. Unless you have a compelling reason to deviate from this norm then choosing one of these two types of mainstream business structures really would be the very best approach.
There’s no right or wrong answer on the business structure that you choose and it really depends on which would best suit your situation.
Sole Trader
The simplest of business structures is that of a sole trader; a self-employed person working on their own. There is no formality to setting up as a sole trader; basically you just get started. No distinction exists between you and your business which means that a sole trader (an unincorporated business structure) has unlimited liability. You are personally liable for the debts of the business should it fail. In reality this means creditors (people or businesses that you owe money to) could attempt to recover any amounts owed to them from your personal assets such as, but not limited to, your house or car.
Limited Company
The fear of unlimited liability is often a reason for a business to be set up as a Limited Company; an incorporated business established through a formal process and registered at Companies House. A limited company has its own separate identity in the eyes of the law meaning that it is very important to keep the financial affairs of the business completely separate from your own finances. In reality this means opening a separate business bank account and applying strict formality around how you extract money from the company.
Ownership of a limited company is by way of shares allocated to and purchased by shareholders. The shareholder(s) appoint director(s) to run the business on their behalf. Directors have legal obligations bestowed on them when they are appointed including keeping accounting records and filing accounts. Of course the shareholder and director can be one and the same person as is often the case in an owner managed business.
The clear advantage of setting up a limited company and trading through such a business structure is the protection of limited liability; if the company fails the debts remain with the limited company and aren’t passed onto its directors unless there has been some wrongdoing, the directors have provided a personal guarantee on any borrowings or more money has been taken out of the business by way of dividends than is available in undistributed profits (termed as taking an illegal dividend). A personal guarantee means that the directors have assured the lender that should the limited company fail they will pay back the borrowings effectively removing the protection of limited liability. Personal guarantees are often required for a company car lease or any sizable borrowings that the company may incur.
Considerations when deciding on your business structure
Forced into Limited Company – freelancers and contractors trying to secure work can be forced into a Limited Company Structure by their end client. On the face of it this could be deemed to be an illegal restrictive practice although it’s a difficult point to argue when securing paid work is at stake. That said, do push back at this as a prerequisite to a contract and, if brave, put your fees up to reflect the costs of the additional administration required for a Limited Company.
Tax Saving -for businesses with larger profits there may be tax savings to be gained if operating under a Limited Company structure although with the forthcoming increase in Corporation Tax such savings have almost been eroded.
Do you need an accountant – if you do operate a Limited Company you will almost certainly need an accountant to help with your year end accounts as they need to be filed in a certain format requiring special software. An accountant will also help you to decide how best to pay yourself from the business by way of a salary and dividend mixture as well as explain how to report dividends on your self assessment, run a payroll for you and file a Confirmation Statement. You may be able to do some of these things yourself to reduce accountancy fees if you’ve the time. However, if you miss a deadline there could be quite a hefty fine. For example, £100 per month if you miss your payroll filing, and up to £1,500 for accounts filed late which would double if you were late in the following year. Not having a budget set aside for accountancy fees is simply not an option if you operate your business as a Limited Company. The accounts and tax returns for a sole trader are much easier and can, in the most part, be done without an accountant if you’ve the time and the inclination.
In either case don’t be afraid to outsource your accounts and tax returns to a reputable accountant, especially if you are too busy to keep the records up to date. Do make sure that you keep control on what you want them to do and agree the fee up front.
Insurance – the unlimited liability attached to operating as a sole trader may be mitigated by taking out appropriate insurances which would give you peace of mind against any potential issues. Shop around for insurance for your particular profession such as professional indemnity insurance for freelancers, trade insurance or public or employer’s liability insurance.
I want to be a Director – setting your business up as a Limited Company simply to call yourself a Director should be something to avoid at all costs. Whilst there is a deemed perception that a Limited Company is more well regarded than a sole trader there is little to back this perception up. There needs to be a much more concrete reason to set up as a Limited Company than a title.
Sole Trader or Limited Company Summary
| Sole Trader | Limited Company | |
| Set Up | Easy | More formalities |
| Protection | Unlimited liability | Limited liability |
| Complexity | Easy & Straightforward | Much more complex |
| Tax Savings | Under £30k profit | Over £30k profit |
| Regulation | Lower | High |
| Perception | Myth that it’s not good | Myth that it’s better |
| Admin | Easy | Hard & accountant needed |
| Accounting Cost | Can DIY or low | Hard to DIY & high |
| Title Snobbery | No formal title | Can be called a Director |
If you’re unsure what to do then The best advice is to start off as a sole trader testing the waters to see if your business works. The business structure can be changed in the future once you’ve proved the business concept and the need for limited liability protection increases as matters become more complex. Keep things simple at the outset unless there is a compelling reason for complexity but make sure this is matched with the budget to get specialist help from a reputable accountant.