Business structure directly impacts how much tax you pay and how you are treated by law. It's worth considering all options before deciding.
With the number of people starting their own business or side-hustle on the rise, we examine one of the most asked questions and delve into the pros and cons of the different business structures.
When starting a business, one of the most crucial decisions to make is selecting the appropriate business structure. This decision impacts multiple aspects such as taxes, liability, and management.
The two main business structures for an individual setting up a business are Self-employment (or Sole Trader) and Limited Company. Each has its unique advantages and disadvantages, which we will explore in detail below.
Self-employment
A Sole Trader is an individual who owns and operates a business on their own, however this does not necessarily mean a single-worker business, you can hire staff or sub-contractors to grow your business. Sole Traders are considered ‘self-employed’ which means one person is responsible for all the business and are therefore entitled to all the risks and rewards this brings.
A Sole Trader must register with HMRC for self-employment as soon as they start trading and the business and the owner are the same in the eyes of the law, this is known as having unlimited liability.
The owner is personally liable for the debts of the business and may have to pay for losses made by the business from their personal funds.
Income is declared on a self-assessment return and Income tax will be paid on this amount. Class 2 and Class 4 National Insurance Contributions may also be required.
Why chose to go self-employed?
Ease of Setup: Setting up as a Sole Trader is straightforward and inexpensive. There are minimal legal formalities, making it accessible for anyone looking to start a business quickly.
Complete Control: Sole Traders have full control over all business decisions and retain all the profits generated by the business.
Privacy: Sole Traders are not required to publish their financial accounts, ensuring a high-level of privacy.
Tax Benefits: Sole Traders benefit from simplified tax filing processes and are often eligible for personal tax reliefs BUT from April 2026 those earning £50,000 or more will need to register for Making Tax Digital (MTD) and file their accounts every 3 months. Sole Traders earning between £30,000 and £50,000 will be impacted from April 2027.
Disadvantages of being self employed
Unlimited Liability: A significant risk of being a Sole Trader is that you have unlimited liability. This means your personal assets are at risk if the business incurs debt or legal issues.
Limited Capital: Raising money to invest in the business can be challenging as you rely solely on personal funds or loans. This can limit the growth potential of the business.
Workload and Stress: Managing every aspect of the business alone can be overwhelming, leading to excessive stress and work-life imbalance.
Lack of Continuity: The business may cease to exist upon the owner's death or incapacity, leading to a lack of continuity.
Limited Company
A limited company is a separate entity from its owner (or owners), which means you are less exposed to legal or financial issues. A company can be owned by one or many individuals, known as its shareholders.
Limited companies have their own legal identity and can use or own assets in their own right.
Liability is limited to the total value of their assets and cannot be extended to its shareholders.
Why choose to go limited?
Limited Liability: A Shareholder's liability is limited to their investment in the company. By separating the assets and liabilities of the business a clear line is drawn between the business and the individual. If anything happened which led to legal action against the company or unpaid business debts, personal assets such as the business owner's house, savings and credit score would be protected.
Access to Capital: Limited Companies can raise capital more efficiently through the sale of shares, making it easier to fund growth and expansion.
Continuity: The company exists as a separate legal entity, ensuring continuity regardless of changes in ownership or management.
Professional Image: Operating as a Limited Company can enhance credibility and professionalism, attracting more clients and investors.
Tax Benefits: Limited Companies have the potential for significant tax planning opportunities and can take advantage of various tax reliefs and incentives.
Disadvantages of Limited Companies
Setup and Administration: Establishing a Limited Company involves more legal formalities, documentation, and ongoing administrative requirements than that of a Sole Trader.
Reduced Privacy: Limited Companies must publish their financial accounts and other information, reducing the level of privacy compared to Sole Traders.
Compliance: Compliance with regulatory requirements means additional time and administration.
Profit Distribution: Profits are distributed based on shareholding, which may not always reflect the effort and contribution of individual shareholders.
Choosing a business structure is likely to come down to the nature of the business, your long-term goals and risk appetite. It is, however, possible to change in the future if your circumstances change.
It is common for a business to start as Sole Traders and grow into a company or even a group of companies. You might change your business structure as you start growing and doing more complex projects which carry a greater financial or legal risk for you as the business owner, in preparation for the sale of your business, or simply to separate risk factors.
Understanding the advantages and disadvantages of each structure will enable you to make an informed decision that aligns with your business objectives and personal preferences.
For detailed advice, tailored to your personal circumstances, contact us at Drury Accountants and ensure that you select the most suitable structure for your entrepreneurial journey.
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