When you decide to start a business, its legal structure determines the level and type of tax you’ll pay, the extent of your personal liability, and how easy it will be to sell the business or pass it on when you retire.
Clearly, it’s one of the first considerations, and although forming a limited company is often seen as administration-heavy and a complex process, this structure offers some distinct benefits over being a sole trader.
Here we look at ten of the advantages being director of your own limited company has over self-employment, and how your decision can affect various areas of your life.
1. Separate legal entity
- A limited company is a separate legal entity from its directors. Third parties enter into contracts with the company itself rather than personally with its officers, providing a degree of security for those involved.
- This is not the case for sole traders, whose business liabilities also fall on them as individuals should the business fail.
2. Limited personal liability
- Personal liability is limited as a director, apart from where cases of fraud or misconduct are identified. Your finances are completely separate from those of the company, offering valuable legal protection if the business experiences financial difficulties.
- There is no such protection as a sole trader, who would be required to pay business debts from their personal funds in the event of insolvency.
3. A professional image
- The fact that the company is incorporated conveys a professional image that can be important when securing new contracts. Limited company status also encourages trust and a sense of confidence from customers, and can attract bigger business.
- In some industries, larger corporations will only trade with limited companies as they perceive this structure to be more credible and permanent than sole trader status.
4. Tax advantages
- Setting up a limited company is more tax-efficient than being a sole trader. Directors are able to take some of their income as dividends, and these payments are not subject to National Insurance contributions. Limited companies are liable for Corporation Tax, which currently stands at 20%, although the Chancellor has pledged to reduce this to 17% by 2020.
- Sole traders have to make Class 2 and Class 4 National Insurance contributions on their income.
5. Access to finance
- The limited company structure is an entirely separate entity from its directors, and presents a lower risk to lenders. This means it can be easier to obtain funding for a limited company.
- Sole traders might also have to pay a higher rate of interest to reflect the greater risk.
6. Intellectual property
- The business name (and therefore other assets such as the company’s website) is provided with more security as a limited company. The name is registered at Companies House on formation, and cannot be used by any other business.
- As a sole trader, there are no restrictions on other sole traders or companies using the business name.
7. Low cost of formation
- The cost to form a limited company can be from as little as £15, so the initial expense may not be as high as is commonly perceived. Although hiring an accountant may be more costly for limited companies, online systems now make the accounting process much quicker and easier, so your accountant may not charge as much for their time.
- The same applies to the administrative tasks associated with limited companies. If you are computer-savvy, you may be able to complete and submit statutory returns yourself, saving the expense of hiring professional help.
8. Share ownership
- Because the company can issue different classes of shares, it’s easy to transfer ownership and attract external investment. As a company director, you have greater control over when profits should be distributed to shareholders, which may be beneficial from a tax perspective.
- Limited company pension contributions are tax deductible, and as such, directors enjoy a tax advantage over individuals having to pay into private pensions as sole traders.
10. Succession planning
- The limited company structure makes selling or passing on the business to a family member more straightforward than as a sole trader.
Real Business Rescue offers independent and unbiased advice to companies from every sector. We are part of Begbies Traynor, the UK’s largest independent corporate recovery firm. We have an extensive network of 72 offices offering confidential director support across the UK.