Sole trader vs. limited company: definition, pros and cons
By Indeed Editorial Team
Published 6 July 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
The type of structure that an individual chooses to start a business significantly affects its profitability, liability, tax implication and growth. Before starting a business, it is important for potential business owners to decide if they want the business to carry the form of a sole trader or limited company. Understanding the differences between a sole trader and a limited company and the pros and cons of each may help a business grow. In this article, we explore the definitions, advantages and disadvantages of a sole trader vs. a limited company.
Sole trader vs. limited company
To understand more about a sole trader vs. a limited company, it's important to know their definitions. Here are the definitions of a sole trader and a limited company:
A sole trader is a type of business run by one person or a close friend. A sole proprietorship is another name for this structure. It is the easiest type of business to start and register. As a sole trader, the individual operating the business is personally responsible for any losses, liabilities and profits that the business makes. A sole trader might depend on personal assets to settle a business debt.
A limited company is a business run by a private organisation. This type of business is usually separate from its owners. Shareholders own and operated by a group of directors. The company has legal obligations and rights. The abbreviation of a limited company is Ltd.
Advantages of running a business as a sole trader
Here are some pros of setting up a business as a sole trader:
easy to set up because it has few legal formalities
profits it earns belong to the business owner
decision-making is fast because it exclusively depends on the business owner
simple to establish and operate
easy to change the organisation's legal structure because of various circumstances
start-up costs can be low
Disadvantages of running a business as a sole trader
Here are some disadvantages of setting up a business as a sole trader:
liability for the business' credits may become the owner's responsibility
limited capacity to raise capital
business decisions may solely depend on the business owner
difficult to maintain high performance from employees
the government may tax the owner as an individual
only one person can establish and own the business
Advantages of running a business as a limited company
Here are some advantages of operating a limited company:
Minimises personal liability
A limited company is a separate entity that can protect a business' assets when the company is under receivership. A limited liability company is a separate legal entity and has its own rights. The business is separate from its shareholders and owners. You can refer to this separation as the ‘corporate veil'. In case of debts, the company deals with those difficulties by itself. A professional image can help the company with benefits, such as:
attracting new clients and investors
creating a trusted, effective brand identity
expanding the business nationally and internationally
creating more opportunities
competing with other businesses in the industrial sector
Limited companies can pay less corporation tax on profits depending on the country they operate in. Less tax can mean fewer expenses. A business can keep surplus income by retaining all profits and reinvesting the capital when the business may need extra funds.
Builds credibility and trust
Having a professional business structure can provide a company with prestige and credibility. Limited companies can disclose their businesses publicly, which may help them network with potential clients and investors. This may be because contracts that the business awards may increase potential risks.
Increases borrowing opportunities
It can be easier for a limited company to borrow money from banks, lending institutions and relatives. Because a limited company provides business information publicly, potential shareholders have access to view its details and may decide to invest in the business. Companies can have multiple owners by selling shares to raise additional capital.
Separates the owner from the business
Companies may be responsible for their debts and liabilities. The owners aren't liable when the company becomes insolvent. The business can declare bankruptcy without affecting the shareholders or directors directly. Companies may enjoy perpetual succession, meaning that once the directors or original members die, the company can still survive.
Related: What is a private limited company?
Disadvantages of setting up a business as a limited company
Here are the disadvantages of setting up a business as a limited company:
setting up legal formalities can be time-consuming in a limited liability company
raising capital and handling various expenses, such as legal fees, can be costly
gathering accounting information can be complex
withdrawing money from the business can take considerable time
maintaining company records for easier reference and making them available for public inspection may be legally required for limited liability companies
Choosing between a sole trader and a limited company
Here are some factors to consider when choosing between a sole trader and a limited company:
With a sole trader business structure, a company's earnings before tax become the taxable income of the business owner. In a limited company, the director may file important documents, such as a set of accounts, a confirmation statement and a company tax return. In addition, each director almost always files a personal tax return to the taxation company. A sole trader may take less time when dealing with the tax collector and filing their taxes as compared to a limited company.
The costs to start a business may vary depending on its structure. A sole trader and a limited company may require different start-up expenses. For example, when setting up a sole proprietorship, legal charges may be low, while the start-up costs for a limited company may be higher. If an individual obtains enough resources and maintains enough patience to complete all the legal documentation, they can start any type of business.
If a prospective business owner requires help with funding or operating a business, they may start as a corporation or a company. Limited companies may be a more suitable structure for receiving funding compared to sole traders and other business structures. Companies can sell their shares to get more investment capital.
Licences and permits
Different laws regarding licences and permits may depend on the business' location. Consider which one may be the most convenient and easy to follow. For a sole trader, the business may require fewer licences than for a person owning a limited company.
A sole proprietorship can be more suitable to set up than a limited company, especially when considering starting a family business. Limited companies require you to disclose a company's information to the public. An accountant can clarify how much privacy each business structure offers.
As a sole trader, according to the law, a business owner and their business are of the same entity. The liabilities of the business become the owner's legal responsibility. For example, if a business cannot pay a certain amount to a creditor, the creditor can take the business' assets. This can also happen when a company or individual sues a business; the lawsuit names the company and the business owner. Under the law, a limited company is independent of its owners and shareholders.
Related: 4 types of businesses to start
Continuity of existence
A sole proprietorship cannot exist without the sole owner. Its existence depends on the business owner. A limited company can help maintain a business even if the directors of the company aren't there. It's important for business owners to consider creating a limited company if they travel regularly or if they're unable to operate it.
Comparison of a sole trader vs. a limited company
There are various ways to distinguish between a sole trader and a limited company. Here are some comparisons between them:
A limited company has limited liability as the corporation forms a legal distinction between the business owner and their business. A sole trader has unlimited liability, meaning when the business gets into debt, the business owner is personally liable.
Limited companies can be more tax-efficient and there are numerous allowances and deductibles that a limited company can claim against its profits. Sole traders may pay more taxes.
Once an individual registers their company name, nobody else can use that name when establishing a business as a limited company. A sole trader business structure can't offer the same protection.
A limited company may bring added responsibilities that may be time-consuming and costly. A sole trader structure can be relatively cheap and easy to operate.
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