Sole Trader Or Limited Company, What’s The Risk?

The most important decision when you become your own boss is choosing your legal structure.

The second most important decision is making sure that structure is right for your business and you.

There are many structures available: the main ones are sole trader, limited company, partnership and limited liability partnership.

I’m going to focus on the two structures chosen by most one man bands, freelancers and bloggers: sole trader or limited company.

Isn’t A Limited Company Always Best?

If you ask traditional accountants and business advisors, they talk about how a limited company is usually best because it protects you against risk.

They don’t mention the other bits too much, like everything involves risk and the paperwork, legal restrictions and financial overheads that go with a limited company are important risk considerations in themselves.

Having a limited company that isn’t appropriate for you can be damaging and expensive. Just ask my clients when they ask me to help sort out the mess.

(If that’s you, contact me, I can help. If you’re a new business and starting to panic, it’s ok, read on.)

What Are Limited Company And Sole Trader?

A limited company is a business that is legally separate to its owner(s).

This means unless you do something illegal, if your business loses money, the losses are separate from your personal finances.

This is good or not good depending on your personal and business tax situation. (A business loss can mean a tax refund. Good, huh?)

One or the other isn’t better, it’s just different. Like carrot cake and chocolate cake.

To read more about what they are and the differences, have a look at Am I A Sole Trader Or A Limited Company?

What Do I Need To Think About?

There are a lot of factors involved. For example:

  • Do you have a job(s)
  • Your income
  • How much your business, freelancing or blog earns or loses
  • Your general tax circumstances
  • Your partner’s tax circumstances if you are married/civil partnership/live with someone
  • Who your clients will be/are
  • Do you own property/have assests
  • Whether you want a mortgage/remortgage in the next 3 years

It’s a long list.

Are you sitting here feeling ‘what on earth! I’m lost, I’m overwhelmed, where do I start?’

Starting is a good start and knowing you feel like you do is also an even better start. Some people get on with making a decision immediately, getting help if needed, and that’s marvellous. Not being that person is also ok.

Not taking action because it’s scary won’t keep you in business very long.

I appreciate it’s easy to say but every business or blog owner and freelancer reading this will know what I mean and be there with you. Do it anyway then reward yourself.

It’s not as daunting if you have someone with you on your side to ask the right questions (contact me and let’s have a chat). Then all you need to do is make a decision you understand, feel confident in and are comfortable about.

Not so bad after all is it?

This post is a practical guide to the importance of risk when you choose your business legal structure, whether you’re a heart-entered business, a freelancer or a blogger wanting to make money from your blog.

The 4 Crucial Factors About Risk

There are 4 crucial factors to consider when making your decision between trading as a sole trader or a limited company.

  1. Your Clients
  2. Your Risk
  3. Your Circumstances and Preferences
  4. Tax

Yes, tax is number 4, no matter how much we like to legally reduce our tax bills. It’s not a good decision to be a limited company for tax reasons if the other factors are against it. It’s easy to do, it’s not easy to undo!

1. Your Clients

Do clients in your industry require you to be a limited company?

My tech clients have contracts with companies like Apple and Apple won’t hire them as a sole trader so they need to be limited companies.

On the other hand, you’d be surprised how many companies will work with sole traders if the benefits are explained. No IR35 issues for them for a start! (Ask me if you’re interested in knowing more).

Ask around your industry so you know what the position is. Is the norm to be sole trader, limited company or does it not matter?

If you’re new, consider the first few years of your business and whom you’d like to work with beyond the initial start up period.

What’s the risk of limiting the clients you want with each structure? Which clients do you want to serve?

 2. Your Risk

What size contracts do you have or will have?

Your risk is higher if the value of your contracts or your income / turnover is higher.

For example, I have a client who makes hair accessories. A £75,000 contract with Selfridges makes her business risk higher than a crafter making hair bands at weekends.

There is more that can go wrong with a bigger contract especially when much more of the risk is outside your control (as with an outside supplier or contract to supply goods). Even then, it depends on individual circumstances and scale and the overall picture needs to be thought about.

Example: You’re a consultant charging £25,000 per contract with only 6 clients (you’re very good). The risk per client may be low (you have professional indemnity insurance, public liability insurance and have no outside suppliers). Even so, your turnover is £150,000. Higher turnover businesses are usually limited companies but if you prefer the minimal paperwork of being a sole trader, consider risk as part of your decision.

Do you have an employed role, a chronic illness or caring responsibilities?

Sometimes the paperwork and legal obligations that is part of a limited company may not be worth the tax saved if that is the only reason for doing it.

Money is important but it isn’t everything if by saving a bit of it you sacrifice energy, time and focus you need for more important priorities (like your health and caring for loved ones, or a demanding job). You can always go limited later but it isn’t easy to go from limited to sole trader.

Do you have assets to lose?

As a sole trader legally you are the business so personal assets may be at risk if there is a problem.

On the other hand, there is always risk, and having a limited company that isn’t right for you is a risk in itself (just ask my clients who found out later how much limited company accounts and responsibilities cost, how harder it is to take money out of a company and how they can’t offset losses or do accounts themselves – that’s why they came to me for help).

Of course make sure you have insurance. It’s more about a sensible risk assessment than flapping about like Chicken Licken and saying you must have a limited company because the sky could fall in.

If you do have a higher risk business, a high turnover or substantial assets or income, it is a good idea to trade through a limited company.

What’s your turnover? What are the risks you can’t control? What are your assets?

Contact me if you desire clarity about your choices.

3. Your Circumstances and Preferences

Risk assessment is more than just about your business if it’s YOUR business, freelancing or blog and no-one else’s.

You need to consider your personal and household income and circumstances – not only your business.

Take some time to do this. It can feel draining all this being an adult and sometimes a cream tea or a cat video can work wonders in pepping you up and freeing your brain.


(one cat video at your service as I don’t want you getting distracted)

What are your financial needs?

A freelance client of mine trades through a limited company because it enables her to protect her National Insurance contribution record and make tax-efficient pension payments. She earns the second income for the family and investing income for the future is her first priority.

You might want to be a sole trader because you work full or part-time or recently left your job. You can often get a tax refund which you wouldn’t be able to do as a limited company. This works especially well in your first year or two in business or monetising your blog when it’s perfectly normal to make a loss. You’ll have more expenses than you realise.

Do you need a mortgage in the next few years? Sometimes it’s worth going limited because of the way banks assess your income. This is only to be done carefully though so don’t do it on impulse.

What are your preferences?

It’s much easier to do the required paperwork for a sole trader.

A limited company has many more legal requirements, deadlines and ‘boxes to tick’ complete with penalties if they aren’t done right or on time.

Some of the record keeping and admin you can do yourself, a lot you can’t and you will need to hire an accountant (that’s where the overheads come in. The cost is usually £500-£1500 no matter how much money you make, or don’t make).

It’s your legal responsibility even if everything is done by your accountant. Do you understand what they’re doing on your behalf? I can help you minimise your accounting bill and understand what your accountant is doing on your behalf and what questions to ask, so if you feel a limited company may be right for you, contact me for a chat (a cream tea is usually included with this service).

What does a sole trader need to do?

A sole trader needs to keep records and file a self-assessment tax return. Most sole traders can do this themselves after some coaching.  Even the coaching is a tax deduction expense!

Some people aren’t suited to keeping up the paperwork required of a limited company. Be honest if this is you. If there are strong reasons why a limited company is the right decision, there are ways of making this an empowering decision and not a draining admin nightmare.

For more information about sole traders and tax returns (and self assessments for directors), read my post How Do I Do My Own Tax Return?

4. Tax

Are your profits for tax or your overall income over £35,000? If so, it may be the right decision to be a limited company.

Why you may want a limited company for tax reasons

Limited companies are taxed differently to sole traders. If your profits or non-business income is £35,000 or over, explore being a limited company for the tax benefits. You pay less tax than if you are a sole trader.

The usual arrangement is paying yourself a basic salary and taking the remainder in dividends (making sure someone does the legal paperwork and sticks to HMRC’s rules).

There are other options, including if you need a mortgage in the next few years or if you know your company will be bringing in money but likely to make a loss in the first few years.

(If you want to have a company for ‘social’ reasons and don’t want the admin heavy route of a charity of Community Interest Company, then there are ways of doing this with the minimum of legal paperwork. Ask me how.)

The tax savings can be great if your business profits for tax are going to consistently be over £40k, you earn over £40k or you have a combined income of over £40k from multiple sources (e.g. job, blog/freelance or job/business/pension).

When to move from sole trader to limited company

Are you a sole trader already?

When your profits for tax/overall income is £35k+ , it is a good idea to explore becoming a limited company.

You may decide you want to stay right where you are (several clients did) but it’s great to have that powerful discussion to take control and put you in charge of your business and going forward.

Why a limited company may not be right

However, there are downsides.  It is easy to incorporate, it is not easy to revert to becoming a sole trader. It isn’t difficult to do your own accounts with some help if you’re a sole trader.  As a limited company you need an accountant and a budget of £700 – £1,500 per year to cover the additional costs. If you have a high or more complicated transaction level, this will be more.

[Edit: It’s not a good idea to incorporate ONLY for tax. One reason why is that tax rules change. Big changes are coming for how limited company directors pay themselves. Find out more here.]

Action: Go for afternoon tea.

Focus on your situation, your business/freelancing/blog, your options and what you need now and in a few years time.

Discuss with loved ones and your coach/mentor and get help with your decision if you need clarity and guidance.

What Now For Your Decision?

This post is my longest yet at over 2200 words.

That’s because your legal structure, whether business, freelancer or blog, is one of your biggest and most important decisions.

It frames your business and interactions, and your personal and business finances.

Talk to other businesses, freelancers and bloggers. What did they do?

Most of us don’t get it right from the start whatever it may look like from the outside. Don’t be afraid to ask about mistakes and how you can learn from them. We’re a community, here to help and support.

Take it one step at a time. Time spent now pays dividends later and that’s a good investment.

 

How did you assess the risks when you chose your business structure?

Are you considering going sole trader to limited?

Are you starting a business and need help making the right decision for you?

 

If you want one to one support understanding whether a limited company is right for you (or not), ask about coaching with me.

If you want to take your business to the next level, learn more about limited companies (or understand the one you already have), have a look at my Limited Company Day Retreat.

If you want easy to understand courses and guides with a sense of humour and mentions of cake, have a look in my shop.

Try my free resources and download an invoice template or income spreadsheet.

 

 

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