How to set up your business: Sole trader or limited company

If you’ve just started a business, you’ll likely be faced with the early decision of registering as a sole trader or as a limited company. But what’s the difference between the two, and why does it matter? 

In this guide, we’ll provide you with a brief overview of the key operational differences day-to-day and in the long term.

Read on to find out:

• What are the differences between sole traders and limited companies?
• How can you set up each business type?
• How Countingup can help

As businesses, the crucial difference between sole traders and limited companies is how many owners there can be:

Each business can have only one person operating it, but only limited companies can expand to include others. This does not mean that sole traders cannot have staff, or other people involved in the business, simply that, on an ownership level, limited companies can grow to involve more persons. 

Each business also operates with a fundamentally different relationship with its respective owner. Sole traders have a closer financial and legal relationship with their business, being personally liable for any debt their business acquires. This is because the business and the individual are treated as one entity. In contrast, limited companies are structured so that the owner(s) and the business are considered legally and financially separate from one another. In order to protect your personal assets as a business owner, forming a limited company offers more protection. 

Because of these differences in ownership, the tax rules each business is subject to are therefore different. Limited companies pay corporate tax while sole traders pay personal income tax rates. Depending on your business’ total income, you may stand to save money registering as a sole trader in the short term but a limited company in the long term. Calculate how your take-home figure changes according to your tax and accounting method with the information available here. 

Sole traders have a more flexible financial relationship with their business and enjoy less administration as they operate. Along with the financial records of the business they run, sole traders should keep personal income records from any additional income they have. This is because they calculate their personal allowance and tax liability at the different rates HMRC requires. In contrast, limited companies must disclose a more detailed accounting record of the business, including other records about shareholder decisions and share offerings. If you’re looking to set up quickly or easily, registering as a sole trader may be more suitable. 

If you’re looking to set up as a limited company, you should be aware of the two types you can register as: limited by shares or limited by guarantee. Only companies registered as limited by shares are allowed to keep their profits after tax. Companies limited by guarantee must reinvest all earnings back into themselves. For this reason, companies limited by guarantee are sometimes referred to as ‘not-for-profit’.

For the rest of this article, we’ll focus on sole traders and companies limited by shares as they’re more common and can both keep their profits. If instead, you’d like to register as a company limited by guarantee, information is available to follow. 

Whatever you choose, setting up your business as a sole trader or limited company has implications on how you pay taxes, find funding and operate. Below we outline the key similarities and differences, as well as links to detailed guides to help you choose.

Registering as a sole trader is as simple as registering for tax self-assessment. 

As you apply, you’ll need to verify who you are and disclose where your business operates. Similarly, sole traders can (but aren’t required to) choose a trading name. There are some rules to follow if you choose a dedicated trading name, including the avoidance of sensitive or offensive terms, pre-existing business names and use of ‘limited’ or ‘Ltd’.

As mentioned previously, sole traders should keep accounting records of their business and any additional personal income they have from other employment. If you’re confident that you’re ready to register, or would like more information about sole traders specifically, check out our guide How to register as a Sole Trader. 

Registering as a limited company involves additional steps. Like sole traders, limited company owners must verify their owner(s) and disclose where they operate the business from. Limited companies must also nominate a director and submit key documents that detail the rules and members involved in the company. If you’re starting out, you’re allowed to register as the director and sole shareholder of the business at the same time.

Limited companies follow similar restrictions in naming their business but are required to keep a more detailed record of business operations and accounts for up to six years. As you trade, it’s vital to record any disclosures and documents correctly. Investors and lenders may look to use this information in order to evaluate your business.

There are some exceptions in the level of record details necessary, depending on your company’s industry. For more information, you can read our guide How to register as a Limited Company. 

We also have guides available for what operating expenses can be claimed and 8 commonly forgotten expenses to help make your books accurate.

Starting a business is an exciting time but too often, new business owners are trapped with their financial admin. With Countingup, managing your accounts is easy no matter what business type you register as. 

With your business account, accountancy software and tax filings in one app, you can gain complete confidence in your business finances and compliance, meaning you can spend more time running your business. 

And with our handy expense reminders and automated invoicing, you can enjoy automated finance admin with no hassle. Find out more here.