The differences between sole trader, partnership and limited company
Discover what each of these business types is and how it differs from the others.
When registering a business in the UK, you will need to choose a business type. Your choices are: a sole trader, a partnership or a limited company.
This decision will have huge financial and legal implications, so it’s important you choose the most suitable business type for you.
What is a sole trader?
If you are the sole owner of a business, you can operate as a sole trader. This is known as a sole proprietorship. It’s also accurate to label yourself as self-employed.
This is the easiest business type to register. All you have to do is register for self-assessment, which you can do via the government’s online registration online portal. The deadline for registration is 5 October of your second tax year, although it’s best to do this as soon as possible if you want to avoid large backdated tax bills. If you fail to register by 5 October in your second tax year, you may face a fine.
As a sole trader, you’ll pay income tax and national insurance on your business earnings, the same as you would on your wages as an employee. The difference is: you’ll pay this every tax year after submitting your self-assessment tax form to HMRC. The online deadline for submitting your tax form is 31 January each year.
Sole traders remain personally liable for their business debts and business lawsuits, even if their company goes bust.
You can hire employees as a sole trader, but by definition, you can’t have a business partner.
- It’s simple to get started
- There’s little paperwork
- You have more flexibility to make structural changes to your business
- Potentially not as tax-efficient as incorporating
- You are personally liable for your business debts
What is a partnership?
A partnership has the same rules as a sole proprietorship, except that your business income is split with a business partner or partner(s).
You’ll pay tax on your share of business income the same way as a sole trader would. You’ll be equally liable for business debts and lawsuits.
Many business owners benefit from shared responsibility and new ideas from a business partner.
If you’re a sole trader who wants to bring a business partner on board, it’s easy. You don’t even have to let HMRC know straight away, unless your business is VAT-registered. The change will be reflected in your self-assessment form for that tax year.
- You’ll benefit from a second pair of hands/ideas
- You split the business income
- You have to agree before making major changes to the business
What is a limited company?
When you set up a limited company (also known as incorporating), your business legally becomes a separate entity to you.
Limited company owners will hold shares in a company and can pay themselves in two main ways. They can take a wage from the company’s overall earnings and they can take a portion of the the company’s post-tax profits. This second type of payment is called a dividend.
The business owners will be responsible for paying corporation tax, and may pay income tax on their wages and dividends as well.
They won’t be held personally liable for business debts or commercial lawsuits. So, if your business goes under, creditors can’t claim what’s owed to them from your personal bank account.
The most common type of limited company is a company limited by shares. This is where shares in the business are split between its owners. Shareholders can take money from the business in the form of dividends.
The second type of limited company is a company limited by guarantee. This type of company doesn’t have any shareholders, but is instead owned by a group of members, known as guarantors. Because there are no shares or dividend payments, these guarantors typically invest any profit back into the business. This ownership structure is primarily used by not-for-profit and community organisations.
When a company has been successful for a number of years, it may decide to sell shares to the public, making it a public limited company.
Limited company owners have to register their business at Companies House. Annual accounts and other basic information about your business must also be shared with Companies House each year.
- Likely to be more tax-efficient
- Limited personal liability for debts or legal problems
- A limited company can be seen as “more professional”
- You have the ability to raise funds by selling shares
- More paperwork
- Less privacy
- It’s more complicated to make structural changes to your business
What are the key differences?
New business owners face a choice between starting a limited company or a sole trader/partnership (depending on whether they have a partner or not).
A limited company is typically a tax-efficient option. Limited company owners have the option to sell shares in their company to investors, if they wish. On top of that, they are protected by limited liability for debts or legal issues. However, it is more complicated and expensive to set up, plus there is more paperwork and reporting involved each year.
Many business owners appreciate the simplicity of being a sole trader or partnership. It’s easier to get started, make structural changes to the company, and to close it down.
It’s possible to shift from a sole proprietorship/partnership to a limited company. It’s a lot harder to shift the other way around. There’s no need to share certain details about your company either.
The bottom line
The simple answer to this decision lies in whether you prefer a simple, flexible business structure, or a more efficient one which offers extra protection and potential tax benefits.
The latter requires more administration and it’s difficult to make changes, but it could be the sensible option for most serious business owners.
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