Some people operate their businesses as a limited company right from the get-go, but many also start out as a sole trader or partnership first and then incorporate (register as a company) later.

So, if you’re thinking about becoming incorporated, what kind of things should you consider? For most people it’s a scary sounding step, so we’ve put together this quick guide.

What’s the difference between a sole trader and a limited company?

Sole traders are self-employed people who normally work alone – like freelancers for example. They own and control their business, and there’s no legal distinction between the person and the business.

This is significant because it means you’re entirely responsible for any claims or debts. If the business runs up debt, you may lose your personal assets to pay for it. This could include your house, car, or savings if the worst should happen. If you’re sued, you could even end up facing bankruptcy.

A limited company is a bit different because they’re considered separate legal entities. In other words, any assets, debts, or liabilities belong to the company, and not to the person or people who own the business.

Some self-employed people decide to convert to a limited company for this very reason – there’s no personal financial risk. There are several other benefits though, which we’ll explore.

Will it affect how I do my bookkeeping?

Bookkeeping is essential for any business to manage its financial affairs properly, so in theory the very fact of needing to do it shouldn’t change. That said, it’s worth noting that limited companies are required to use double-entry bookkeeping, where transactions are recorded with their opposite entries.

Operating as a limited company might also mean you encounter other bookkeeping requirements for the first time, such as a director’s loan account.

Can I own a limited company by myself?

Absolutely! You don’t actually need to have ‘company’ to form a private limited company (we stand by this pun without apology). Similarly, a sole trader doesn’t actually have to go it alone, and can employ people if needed.

You can decide to be the only director and shareholder, which gives you sole control over the company, or you can run it jointly with others if you want to.

Why would I want to change from being a sole trader to a limited company?

There are actually several really good reasons why you might decide to make the leap. It could be that you’re earning more and now need to be more tax efficient, or to change how the business is perceived. We go into more detail below.

No-one wants to pay more tax than they have to! Which is why some sole traders find it more efficient to operate as a limited company, especially once the business starts earning more.

To take money out of the limited company, you can use an efficient combination of:

• A small salary (under the National Insurance threshold), which your company can offset against tax.
• And dividends, which aren’t subject to National Insurance, but you will pay tax on.

Trying to get your head around this can be really difficult, especially when it comes to working out what your tax savings will be. Your calculation depends on things like your business’s circumstances and whether you have any other income streams, so your accountant is your best port of call here.

Limited companies are more likely to attract serious investors

When it comes to growing your business, you might decide to look for investment. If this is the case, being incorporated can be a huge leg up.

As a sole trader it’s difficult to sell part of your business – you are the business! That is, unless you’re willing to go through the (sometimes complex) process of forming a partnership. But as a limited company you can raise funds by selling shares to an investor fairly easily. Some investors or lenders simply prefer to deal with limited companies because of the limited liability aspect.

Changing the image of the business

Working as a sole trader makes it pretty apparent that you’re working alone. It shouldn’t make any difference, but it can sometimes make it more difficult to secure work or funding.

Because limited companies require a bit more admin and reporting oversight, they can sometimes be seen as more stable. In some cases, such as organisations inviting tenders for a project, being a limited company might be one of the requirements to secure work.

If you decide to incorporate your company, the business name is registered with Companies House. Once this happens, no other organisation can use it. If you stay as a sole trader there’s no protection for your trading name at all.

Another business may (knowingly or unwittingly) copy it. And if, for example, this other business starts offering a very similar but lesser quality product to yours, your reputation is likely to get dragged through the mud – with no comeback.

We’ve touched on this already but it’s important to really appreciate what this means.

Most businesses have liabilities, and usually debt too. Whether that’s buying stock on credit, purchasing assets, or keeping a business property running, there can be a lot of costs.

Like with your home accounts, if your business spends more than it makes, it’s a one-way ticket to debt. In an ideal world, you’ll be able to manage your business and avoid this, but it’s not always so straightforward. When something out of the ordinary happens (like a global pandemic, for example) it can have a serious impact on a business.

Although even sole traders can have insurance to protect them, a company has an extra layer of protection because of its limited liability, so owners aren’t liable for debts personally. If you do go down this route, your own house, car, savings, and other assets are safe should the company struggle, or even fold altogether.

Don’t forget: There are still benefits to being a sole trader too

Becoming a limited company certainly has its plus points. But there are still some very good reasons why you might want to remain a sole trader.

The first is regarding your earnings. If you only earn relatively little from your business, perhaps as a part time freelancer for example, then you’ll want to keep your accounting and tax as simple as possible.

Some people decide that the nature of their business means they simply don’t need to have limited liability, because there won’t be debts or assets to worry about.

It actually does cost money to become as limited company, and if these costs are higher than they would be as a sole trader, then there may not be much point in converting unless you have to. Again, well worth a chat with your accountant.

Finally, there are extra admin and bookkeeping tasks involved in being incorporated that will likely take up your time and money, especially if you need to pay someone to do it.

I want my sole trader business to become a limited company. When and how do I do it?

So, you’ve been in business a few years and hopefully the cash is flowing in nicely. Now’s the time to think about incorporation.

Every business is different, so do your homework and take professional accountancy advice too. You need to be totally sure this is the right step.

Definitely ready? Here’s what you’ll need to do:

• Decide if you’re going to be the only director, or if other people will be directors too
• Set up a business bank account for your limited company – it’s a requirement that companies have their own account, separate to their owners
• Notify HMRC to tell them your legal structure has changed. This is really crucial as it will affect the amount of tax you’ll have to pay, and when
• Pick a name for your new limited company
• Create your memorandum and articles of association, so you can register with Companies House
• Let your insurer know that you’ve altered your legal structure

How much does it cost to set up and maintain a limited company?

Companies House will charge a nominal incorporation fee to set up your limited company. After that, the only other statutory cost of maintaining a limited company is £13 per year. You need to pay this when you file your Confirmation Statement with Companies House every year.

Twenty-one months after you’ve formed your limited company, you need to file your annual accounts with Companies House. This should be done every 12 months from then on. You’ll also need to deliver an annual Company Tax Return and accounts to HMRC too.

Again, it’s well worth considering looking into working with an accountant, especially if your finances are complex. You’ll find a step-by-step guide to setting up a company on Gov.uk.

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Elizabeth Hughes

A content writer specialising in business, finance, software, and beyond. I'm a wordsmith with a penchant for puns and making complex subjects accessible.