You’ve finally mustered up the courage to wave goodbye to your boss and are now going solo. Surely you didn’t think this would be easy, did you?
As a matter of fact, many who have made the same choice know that this is just the beginning.
This is the time for a series of decisions to be made. You can take comfort in the fact that once your company formation is in place, each step along the way will be easier.
A key decision to be made when starting your own business, or becoming self-employed for the first time, is to decide what type of business structure you want to follow.
There are a number of options, all of which have their merits and differ in legal and taxation terms – but your four key options are as follows:
- Sole trader
- Limited liability partnership (LLP)
- Limited company
Simon Renshaw, director of AABRS, explains what you need to know about each.
On your own as a sole trader
By opting for the sole trader route, you and your business are effectively one and the same – from both a tax and legal perspective.
This means that you are personally responsible for the business – and any debts it incurs.
The profits you make, which are sales minus costs, until April 5 of each year are declared on your tax return and classed as your personal income that year – even if it is not paid out as salary or into to your personal bank account.
Just be aware of changes with Making Tax Digital. Businesses with a taxable turnover over the VAT threshold (£85,000) must follow MTD rules. This means keeping digital records and using specific software to submit your VAT returns. Businesses with a taxable turnover below £85,000 will be expected to follow the rules for their first return on or after April 2022.
You need to follow the requirements for Making Tax Digital for Income Tax if you are self-employed or a landlord from:
- April 6, 2026 if you have an annual business or property income of more than £50,000
- April 2027 if you have an annual business or property income of more than £30,000
There are benefits associated with operating as a sole trader. They include:
- Simple set up and administration. One of the main advantages of operating as a sole trader is how easy it is to set up and run. You have to be VAT-compliant, deduct and pay PAYE and National Insurance to HMRC if you have employees and file a self-assessment tax return, but that’s where your obligations end. Bear in mind that Class 4 National Insurance Contributions (NICs) will be reduced from 9 per cent to 8 per cent and Class 2 NICs will be scrapped. Both changes come into play from April 6, 2024.
- There are fewer financial restrictions. It’s much easier to take money out a sole trader than a limited company. You can take money out of the business as and when it’s needed. That’s because your personal finances and the business’ finances are one and the same.
- There’s greater privacy. Certain information about limited companies has to be made public. Being a sole trader is different. All the details about the business can be kept private. That provides greater anonymity (for example, if you are running the business in your free time while being employed) and reduces the costs associated with filing annual accounts.
- The business is easier to close down. Closing down a limited company takes time and can be costly, particularly if it has debts. Winding up a sole trader is a relatively simple affair, although if there are debts you cannot repay then it can be problematic.
“I started my company in 2007 as a sole trader. This was the easiest of the choices at the time and meant very little work to set it up,” said Graeme Thomas, owner of Johnny F Designs. “I simply called HMRC, told them I wanted to start trading under Johnny F Designs as a sole trader, and that was it.”
A partnership: It takes two to tango
A partnership arrangement is similar to that of a sole trader but differs in that it has more than one owner.
All partners own a specified percentage of the profits, and the liabilities, so they must pay tax on that percentage.
As with a sole trader, each partner’s share of the profits is treated as their income.
There are benefits associated with running a partnership, both when compared to a sole trader and a limited company:
- Shared responsibility. Having more business owners allows the financial and operational responsibility for running the business to be shared. Tasks can be assigned according to skills and the individual workload can be reduced.
- Flexibility. Conventional partnerships are easier to form than LLPs. The internal structure is also versatile as changes can be made to the legal rights and responsibilities of partners and even to their profit-sharing ratios.
- Decision-making. Partners share the decision making which can be a beneficial as there are more brains to pick. However, it can also be problematic if not everyone agrees.
Limited liability partnership (LLP)
In a nutshell, this type of structure has some of the same characteristics of a conventional partnership, such as the internal management, tax liability and the distribution of profits, but it also provides the limited liability of an incorporated company.
Limited liability partnerships tend to be used by professional services firms such as solicitors and architects. The benefits include:
- Tax transparency. LLPs are generally not taxed as corporations, so they do not need to pay corporation tax. Instead, each member is taxed through self-assessment as a self-employed individual.
- Flexibility. The internal structure of an LLP is just as versatile as a conventional partnership, so changes can be made to the rights and responsibilities as necessary.
- Professional standing. Limited liability can enhance the professional standing of a business over and above a conventional partnership. This can be advantageous when trying to win high-value contracts.
- It’s easy to appoint new members. Unlike an LTD, there’s no share capital in an LLP. That means new members can be appointed without having to issue new shares.
- National insurance savings. An LLP do not have to register as an employer if the only people working for the company are members. That can lead to significant national insurance savings.
- Easier to make decisions. There aren’t any requirements for those involved in LLPs to make decisions by resolution or to hold board meetings or general meetings as is the case in LTDs.
Limited Company (LTD)
In the case of a limited company, the business becomes a separate legal entity entirely. This means that the company must be formed, or incorporated, and registered at Companies House.
It will also have to have certain standard legal documents that govern what it can do and what business it operates in.
The company will be owned and controlled by those who own its shares and you can allocate shares to any number of people when the company is incorporated.
You could keep all the shares for yourself, allocate some to a spouse, or sell them (‘equity’) to raise funds.
This does however require more administration, for example annual accounts being filed at Companies House and an annual corporation tax return, but these can be taken care of simply and quickly by an accountant.
Having a limited company comes with significant benefits, which include:
- Tax efficiency – due to the ability to receive income in the form of both salary and dividends
- Reduced risk – liabilities (debts) of the business are separate from that of the owner(s), reducing the risk if things go wrong
- Image – they tend to convey a more professional image of the business
- Flexibility – since equity can be sold, limited companies are easier and more flexible when it comes to raising investment and funding.
“The company was set up as a limited company so that if the business was to incur debt and go bust, my personal situation would not be impacted negatively,” said Brian Lonsdale, managing director of Smarter Digital Marketing. “I also chose this option as it allowed me to bring in another director and divide company shares up. It allows room for expansion and growth in the future.”
So now is the time to ask yourself what exactly is holding you back, and why. If you’ve already thought about it, and have spent five minutes reading this article, you must be considering this seriously.
Just weigh up the options, crunch the numbers and get on the ‘entrepreneurship’ bandwagon.
WXY is a Manchester-based social media and experiential PR agency founded by Gemma Wieczorek and Marc A Young (pictured). Created in 2018, the pair decided to form a limited company over the other options.
Gemma: There are a number of options to choose from when setting up a business and, of course, no one-size-fits-all solution. Neither Marc or I hail from a finance background, with any discussion around money focused on clients.
We found that partnering with an accountancy firm allowed us to start having conversations around how we want to be paid and our tax obligations.
When you start a business, you just want to get cracking. However, setting up as a limited company allowed us to take a step back and sort out fundamentals. There’s certainly an element of ‘it feels more real’ when we see it black and white on Companies House, not to mention some of the key financial benefits of doing so.
I’d recommend anyone in the early stages of a business to find a great accountancy partner who will guide you through the process of setting up a limited company.
Marc: Before we formed WXY, Gemma and I worked together at an independent agency. For us, setting up as a limited company installed legitimacy into our business venture.
More paperwork might sound like a drag but for me it has driven me to ensure everything’s up-to-date as it has played on my need to be organised, which is essential.
It was an additional job that we had to do and allowed us to work together on something that wasn’t part of our previous work relationship. It also allowed us to have open and honest discussions about money, forecasting and choosing preferred suppliers.
Further reading on company structure
Setting up a business: Sole trader vs limited company – Emily Coltman of Freeagent discusses the main differences between registering as a sole trader and as a limited company
6 examples of sole traders – What jobs are best if you want to go self-employed? We look at what it takes to become a personal trainer, a gardener, a hairdresser, a private chef, a photographer or a dog walker
Checklist for going self-employed – a Small Business guide – Deciding to go self-employed is a big step for anyone. Follow this guide to going self-employed and be confident. We’ve got your back