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Table of Contents
- What is a sole trader?
- What are the advantages and disadvantages of being a sole trader?
- What is a limited company?
- What are the advantages and disadvantages of being a limited company?
- What is a partnership?
- What are the advantages and disadvantages of being in a partnership?
- How to register your business
So you’ve had a great idea for a business, settled on a sector, and now you’re ready to become your own boss. Congratulations!
But before you can start trading, you’ll need to pick a company structure and register your business.
If you’ve never started a business before, then this can seem daunting. There are many aspects to consider when deciding between being a sole trader vs a limited company, and things get even trickier when you throw partnerships into the mix.
Read on to learn more about the different company structures in the UK and to understand the pros and cons of being a sole trader, forming a business partnership, or setting up a limited company. We’ll even walk you through the process of registering your business.
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What is a sole trader?
If you operate as a sole trader, then you will own your business exclusively, with no legal or financial separation between you – as a private individual – and your business.
In many ways, being a sole trader is the simplest way to run a business. It’s also the quickest type of business to set up. This explains why more than half (56%) of private businesses in the UK are run as sole proprietorships, according to the latest data from the Department of Business & Trade.
If you choose to operate as a sole trader, then there will be no shares in your business (since you own it exclusively) and you will be held fully responsible for running the business and meeting any associated legal requirements.
It’s also worth bearing in mind that you can be a full-time sole trader, or you can work as a sole trader alongside another job. You can employ staff as a sole trader, although this will involve registering as an employer with HM Revenue & Customs (HMRC).
🤓 Nerdy Tip
If you’re planning to set up your business as a side hustle alongside a day job, then being a sole trader is likely to be the simplest and easiest way to run your business.
What are the advantages and disadvantages of being a sole trader?
Being a sole trader is great if you want total control over your business, with all the advantages and disadvantages this entails.
It’s also the cheapest and easiest business structure to set up – which largely explains why sole traders account for a majority of UK businesses.
The key perk of being a sole trader is that you’ll get to keep all post-tax profits and make all the decisions relating to your business.
However, with great power comes great responsibility, and the flipside is that sole traders are totally liable for any debts incurred by their business.
And with no legal separation between you and your business, this could mean that you will be forced to pay, out of your own pocket, to settle any business debts. If you cannot pay what your business owes, then your personal and business assets may be at risk.
Another disadvantage of being a sole trader is that it can be harder to raise funds than if you run a limited company (which is able to issue shares in return for investment).
What is a limited company?
If you run your business as a limited company, you will need to incorporate (i.e. legally set up your business as a company). You can incorporate a company from scratch or incorporate an existing business as a limited company.
Most limited companies are limited by shares, in which case shareholders will own a stake in your company.
Some limited companies are limited by guarantee, although this structure usually only applies to not-for-profit organisations.
Companies that are limited by guarantee do not have shares. Instead, they are owned by guarantors who accept a set amount of liability for the company’s debts. Any profits made by the company are invested back into the company.
As the owner of a limited company, you will be legally distinct from your business. Your liability will also be limited – meaning if your company goes into debt, you can’t be forced to repay more than you have invested in the company.
As a company director, it’ll be up to you to handle the routine management of your business, but assuming your company is limited by shares, your shareholders will occasionally be able to vote on certain aspects of how the company is run.
You’ll run the company on behalf of your shareholders. You can be both a director and a shareholder at the same time.
Your company will be able to keep any post-tax profits, and you will be able to use the company to pay yourself a salary, a dividend (a payment issued to shareholders from your company’s profits) or you can earn a salary and top it up with dividends.
An estimated 38% of all private sector businesses in the UK are run as limited companies, making this the second most common business structure after sole proprietorships.
» MORE: Should I register as a sole trader or limited company?
What are the advantages and disadvantages of being a limited company?
If you choose to incorporate your business and operate as a limited company, your business will be a distinct legal entity, separate from you. This comes with its own set of pros and cons, which you’ll need to consider before deciding on a business structure and registering your business.
One major advantage of running a limited company is that the potential cost to you is limited – as the name implies.
So while you can lose as much money as you invested in the business, your personal assets (excluding anything you’ve pledged as a guarantee) won’t be at risk if things go wrong and your business goes into debt.
Another advantage of running your business as a limited company is that it could make it easier to secure funding, since you’ll be able to offer investors a stake in your business.
Setting up as a limited company is a bit more complicated and expensive than setting up as a sole trader, but for some people it’s a more tax-efficient way to earn money.
The reason for this is that the rates of corporation tax paid on business profits are lower than the income tax rates paid by sole traders. The directors of limited companies are also able to pay themselves a small salary (to take advantage of the tax-free personal allowance) and top up these earnings with dividends, which are currently taxed at a lower rate than incomes.
On the other hand, one of the biggest disadvantages to registering as a limited company include a greater (and more expensive) administrative burden than operating as a sole trader.
Limited companies have to be registered with Companies House, which comes with a fee of £50, and the company’s accounts must be publicly filed, which can be an administrative headache as well as resulting in less financial privacy.
There are also greater legal responsibilities for company directors than for sole traders, making this a generally more difficult and involved option for many businesses.
What is a partnership?
Partnerships are businesses where more than one person shares the responsibility for running the business.
The most common type of partnership is a business partnership, but businesses may also form limited liability partnerships to combine some of the benefits of being in a partnership with the benefits of running a limited liability company.
Business partnerships
In a business partnership – also known as an ordinary partnership or general partnership – all partners are fully responsible for any debts owed by the business. All partners share the profits, and each partner pays tax on their individual earnings.
In this regard, being in a business partnership is like being a sole trader. There will always be the potential that you’ll have to pay, out of your own pocket, to cover your business debts if things go badly for the business.
The partnership will be governed by a partnership document, which sets out the ownership structure and liabilities of the partnership and states how the profits will be split. The partnership agreement also makes clear what would happen if one partner were to leave.
It’s worth noting that partners don’t have to be people – they can be other businesses, for example.
But in all cases, an ordinary partnership will have a ‘nominated partner’ who is responsible for managing the partnership’s tax return and keeping business records.
Around 6% of all private businesses in the UK are estimated to be operating as ordinary partnerships.
Limited liability partnerships
Limited liability partnerships, on the other hand, are a type of partnership which benefits from the legal separation of personal and business finances – just like running a limited company.
In a limited liability partnership, the partners’ potential personal losses are limited to however much they invested in the business – plus any assets pledged in personal guarantees.
As a member of a limited liability partnership, you will have to pay taxes on your share of profits and register with HMRC as self-employed.
Limited liability partnerships also have to be registered with Companies House and must draw up a members’ agreement stating how any profit from the business will be divided.
What are the advantages and disadvantages of being in a partnership?
The specific advantages and disadvantages of registering your business as a partnership depend on whether you’re planning to form a business partnership or a limited liability partnership.
The pros and cons of a business partnership are similar to those of sole proprietorship.
While business partnerships are simple to set up and run, members of the partnership will be fully liable for any debts incurred by the business.
And while being in a partnership may make it easier to raise funds (since there are more people who have a stake in the business), the flipside of this is that disagreements may come up between partners.
Similarly, with limited liability partnerships, you’ll have some of the benefits of running a limited company. The key advantage here is the separation of personal and business finances, which protects partners’ private assets in the eventuality that the business struggles financially.
There is also the potential for many of the same tax efficiencies gained by running a company rather than trading as an individual – and setting up a limited liability partnership may make your business appear more professional and credible.
In terms of disadvantages, a limited liability partnership can be harder and more expensive to run, with partners obliged to register the business with Companies House and publicly disclose their income from the business.
You should also be aware that limited liability partnerships can only be run with two or more members. This means that if a partner or partners leave the business, and only one partner remains, the partnership will have to be dissolved.
How to register your business
Once you’ve decided on which business structure would work best for your business, the next step is to formally register your business.
The specifics of this process will vary depending on which business structure you have chosen.
Register your business as a sole trader
To set up your business as a sole trader, simply register for Self Assessment with Gov.uk. Even if you have already registered for another reason, you’ll need to do so again. This process is free.
You’ll need a National Insurance number to register for Self Assessment. If you don’t already have one, you can apply on the Gov.uk website.
Before you register, you will need to choose a name for your business. This name cannot be offensive, and nor can it be too similar to another company’s trade mark or contain the words ‘limited’, ‘Ltd’, ‘limited liability partnership’, ‘LLP’, ‘public limited company’ or ‘plc’.
You will also now have to start keeping records of sales and income, business expenses, and other information relating to your business. For a full list of records, check the Gov.uk website.
If you set yourself up as a sole trader, bear in mind that you’ll need to pay Income Tax and National Insurance (subject to thresholds and allowances) on the profit your business makes.
As a sole trader, you will be classed as self-employed for tax purposes. This means you will need to file an annual tax return, which you can do either by using the government’s online service, by sending paper forms by post, or by using commercial accounting software.
You must also register for VAT if your total taxable turnover for the last 12 months goes over £90,000 or if, at any point, you expect to exceed that threshold in the next 30 days.
Register your business as a limited company
Registering a limited company is more involved than setting up as a sole trader.
You should start by choosing a name for your company. Your company name can’t be the same as another registered company’s name and should typically end in ‘Limited’ or ‘Ltd’.
You will then need to appoint your company director. In this case, this will probably be you.
As a director, you will be responsible for keeping records, filing the company’s accounts and tax returns, and paying Corporation Tax.
Before formally registering your company, you will also need to prepare some essential documents.
These include a ‘memorandum of association’, which is a legal statement signed by all initial shareholders or guarantors agreeing to form the company. You’ll also need ‘articles of association’, which are written and pre-agreed rules about how the company will be run.
Once you’ve sorted all your paperwork, and committed to start keeping records of everything relating to your business, you can officially register your limited company.
You can visit the Gov.uk website to register your business with Companies House. You also have the option of registering by post, using an agent to handle registration on your behalf or using third party software.
You’ll need to provide some personal information to register, and you’ll have to pay a £50 fee. In return, you’ll receive your certificate of incorporation, which is legal proof that your company exists.
When you start trading, you’ll then have three months to register for Corporation Tax.
Register a business partnership
To set up a business partnership, you’ll need to choose a name for the partnership and designate a ‘nominated partner’. This is the member of the partnership responsible for sending the partnership tax return.
When choosing a name and setting up a business partnership, the same rules apply as for sole traders.
Remember that all members of the partnership will also need to register with HMRC and send their own yearly tax returns as individuals. These individual tax returns are distinct from the partnership tax return.
You can register the partnership for Self Assessment on the Gov.uk website or by post. Registering for Self Assessment is free. If your VAT taxable turnover is more than £90,000, the partnership must also register for VAT.
Register a limited liability partnership
To set up a limited liability partnership you’ll need to choose a name for the partnership which isn’t the same as an existing company name. This name must end in ‘Limited Liability Partnership’ or ‘LLP’.
You’ll also need to settle on a registered address for the partnership. This will be publicly available information.
You – and the other partner(s) – must then draw up a partnership agreement, stating how the partnership will be run.
The limited liability partnership must be registered with Companies House, which costs £50 if you do it online. The Gov.uk website recommends using third party software to register your LLP.
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