If you’ve recently set up or are thinking of setting up a business, then you have probably come across the term ‘limited company’ by now. For many, self-employment is a chance to become recognised as a genuine brand and registering as a limited company can be the first step in achieving this. But what exactly are the advantages of going limited? Surely, working as a sole trader is enough to get most businesses by?
Unfortunately, it is often this philosophy that sees start-ups fail to reach the heights they were expecting. Whilst sole trading is certainly a viable way of conducting business, it can also be a very risky strategy. To understand this better, it’s worth knowing a little more about the differences between the two methods.
What is the difference between being a sole trader and a limited company?
There are over 3.6 million people currently making a living from sole trading in the UK, according to the British Chambers of Commerce, which just goes to show what a popular business structure it is. The simplicity of trading in this way means it is very easy to keep track of finances and set aside money for taxes. With no setup costs and only one self-assessment tax return to file a year, this seems, at a glance, like the most convenient way to do business.
However, there is one major catch. Because a sole trader isn’t recognised as a registered business, any money you sink into this enterprise is left unprotected by government laws. Personal assets such as houses and cars are at risk should your business fail and you’re left with debts to settle. Limited companies aren’t at the same risk because they are seen as a separate entity to your personal finances. Should your company go under, then there is next to no chance that you will be personally liable for it.
Which companies benefit the most from going limited?
Deciding when to go limited can all come down to how much revenue your company is making. Most businesses won’t benefit from the perks of incorporating until they are showing profits of around £25,000 a year. This is mainly due to the introduction of registration fees and corporation tax when a company is incorporated. Once these are deducted from your yearly income, you could be taking home a very small salary.
However, for companies beginning to turn larger profits, forming a limited company can actually be more cost efficient. Tax reliefs are available on business expenses, so if you have paid for uniform, equipment or machinery, then they are usually exempt from corporation tax. For small businesses producing profits of less than £300,000 a year, this can mean significant savings, especially if you pay your shareholders in tax-free dividends. If you are in doubt over the classification of an expense, then it is worth asking an accountant for their advice.
How will I know when to incorporate?
There is no definitive answer to this question, but you can work out a good turning point by combining the factors above. Firstly, you need to consider your liability. Are you largely funding the company yourself? And do you stand to lose a significant chunk of this money if something goes wrong? Because this risk is so high if you are a sole trader, many businesses choose to go limited, even if they aren’t turning massive profits. For example, if you are running a martial arts business and one of your participants is seriously injured in a training session, you could become liable for any legal claims. Although you can take out insurance policies to minimise the risk, one small mistake or misread clause in the paperwork could leave you vulnerable.
The main thing to remember is that you can incorporate at any time. If you begin to worry about the security of your finances, then going limited might be the right step to take.
Chris Weston is director of Aston Black Accountants.