When you set up a business, running it as a sole trader is the simplest avenue, as there’s not a lot of administration to deal with. But should you incorporate your business and run it as a limited company?
In today’s article, we’ll answer that question by looking at the pros and cons of incorporating a sole trader business. Then, we’ll discuss when is the best time for sole traders should at least consider making the switch. This is a nuanced topic, so make sure to talk with your accountant or a business adviser before you make a decision.
The pros of incorporating your business
Let’s begin by going over the advantages of incorporating a business.
- Limited liability
One of the main advantages of running a business as a limited company is the protection it offers to your personal assets.
As a sole trader, you and your business are legally the same entity. This means that your business incurs debt, and your personal assets are at risk.
A company, on the other hand, is its own legal entity. Therefore, the company – and not you – is responsible for its debts. The only personal assets at risk are those that you invest in the company.
- Tax benefits
Companies pay corporation tax on their profits rather than income tax, which is what sole traders pay. This offers a significant advantage, as corporation tax is typically lower than personal income tax rates, allowing them to retain more of their earnings for reinvestment, growth, and other expenses.
If you run a company, you may also be able to pay yourself more tax-efficiently, as you can pay yourself with dividends, which are taxed less harshly than regular income sources like salaries.
- Access to capital
Companies can usually raise capital more easily than sole traders because they can issue shares of stock to investors. This mechanism provides a substantial source of funding for expansion, research and development, and other growth initiatives.
The cons of incorporating your business
Now, let’s look at the disadvantages of running a limited company.
- More administrative work
Setting up and running a limited company involves more complex paperwork, including accounting and reporting requirements, compared to being a sole trader.
- Higher costs
Because of more complex paperwork, limited companies often face higher running costs, such as accounting fees and annual compliance fees paid to Compliance House. Note that there is also a setup cost (although this is a relatively low cost).
- Greater scrutiny
Limited companies are subject to more oversight and reporting requirements, including filing annual accounts. They must be complete and are publicly available documents.
- Potential loss of personal control
If you bring in investors or additional directors, you may have to cede some level of control over business decisions. This can be a significant shift if you’re used to having complete control as a sole trader.
When you should consider incorporating your business
Deciding whether you should incorporate your business should be based on your business’s specific needs and goals. Here are a few scenarios where incorporation might be beneficial:
- High risk: If you operate in an industry where there is a high risk of failure, incorporation may make sense so you can protect your personal assets.
- Seeking investment: If you’re looking to attract investors or venture capital, incorporation can be extremely helpful, as investors can be attracted to a company’s business structure.
- Tax planning: If your business is generating significant profits, incorporation might make sense as the higher (40%) and additional (45%) rates of income tax are higher than the top band of corporation tax (25%).
Whether you incorporate your business or not is a big decision that should be carefully considered.
If you need help deciding whether incorporation is right for your business, get in touch with us. We’ll examine your business, weigh up the pros and cons, and give you our honest opinion.