Sole trader or limited company: Which business structure is best? When is the right time to incorporate your business? Small business accountant Tamara Spencer looks at the pros and cons of creating a Limited Company Tamara Spencer June 21, 2022 3 min read Our experts We are a team of writers, experimenters and researchers providing you with the best advice with zero bias or partiality. This article was authored by: Tamara Spencer You’ve had a great idea and decided to start your own business. You’ve probably looked on the internet and realised that an unexpected choice you have to make is whether to form a limited company or operate as a sole trader.There are advantages and disadvantages to both. So the question is, should you incorporate your business or remain as a sole trader? Here are the main pros and cons to help you decide:AdvantagesIncorporation normally provides limited liability. If a shareholder has paid for his or her shares they cannot normally be required to invest any more in the company. However, banks often require personal guarantees from the directors for borrowings and the same is usually true if the company leases premises. The advantage of limited liability will generally apply in respect of liabilities to other creditors;A company enjoys legal continuity. It can own property, sue and be suedEffective ownership of the business may be readily transferredBanks are usually able to take extra security by means of a “floating charge” over the assets of the company which should increase the extent to which the business can borrowA company can establish an approved pension scheme which can provide greater benefits than self-employed schemesEmployees can be offered the opportunity to purchase shares in the companyThe liability of executors acting for deceased shareholders, or of trustees, is clearly definedThe tax rate is comparatively low. The small companies’ rate of corporation tax means that profits can be kept in the business at comparatively low rates of taxIt may be possible to dispose of a part interest in the business to a purchaser in the futureDisadvantagesCosts are incurred on the setting up of a company and there are annual administrative costsThe costs of preparing annual accounts are greater for a limited company as the accounts have to be in a prescribed format and comply with the Companies ActIt is unlikely that a small business will be required to have a statutory audit but some industry sectors must have one irrespective of size. This can lead to significant additional costs.Directors will be taxed under PAYE with higher NI contributions than for the self-employedThe company will have to pay employers’ NI contributionsDividends do not go towards pensions. Although dividends can be paid and do not attract NI, they do not rank as relevant earnings for pension contributionsAll shareholders are entitled to a dividend. If a dividend is declared, all shareholders are entitled to receive it unless there are different classes of shares or there is a formal dividend waiver procedureThere are much stricter regulations concerning employee and director benefits, especially in respect of cars.As you can see, there is no simple answer to the question and one size definitely does not fit all. But when starting out, you need to keep costs to a minimum so there is a case to be made for being a sole trader initially – you can always convert to a limited company later.The main reason against this approach would be if you are operating in a business that could be classed as being a risk to customers, the public or employees. In this case, incorporation would mean that if a catastrophic accident occurred and damages were awarded in excess of your liability insurance, the excess would fall on the company and not on you.The other reason to incorporate from the outset is if friends and family want to invest in your business where they would obviously want to have shares.It is strongly recommended that you talk through the issues with your accountant to make sure that you choose the structure that is most suitable for you.Tamara Spencer FCA is a fellow of the Institute of Chartered Accountants and the co-founder of small business accountancy firm Network4M. www.network4m.com Share this post facebook twitter linkedin Tamara Spencer