Should I Set Up a Limited Company?

When starting a new business, one of the most important considerations is the structure and legal status your company will adopt, and specifically whether you should set up a limited company or operate as a sole trader or partnership.

The decision you make will significantly affect every aspect of your business, from your earnings and tax obligations, to administrative burden and liability.  As a result, it is important to consider all the potential implications, both in terms of personal risk and finances, and the future of your fledgling company. 

What is a Limited Company?

A limited liability company is a type of business which is legally separate from its owners.  It must be incorporated at Companies House and is governed by the Companies Act.  While a limited company may have several directors or owners, the company is a legal entity in its own right, can enter into contracts in its own name, is responsible for its own actions, debts and liabilities, and has the right to keep sales income and profits. 

In contrast, a sole trader is a self-employed individual with full ownership of their business.  In this case, there is no legal distinction between the business owner and the company – they are effectively one and the same. 

What is right for my business?

Personal Risk

The most important advantage of a limited company is that it is legally distinct from the identity of the owner. This means that the directors’ own personal finances and assets are not linked to the company and are protected from any debts or liabilities accrued.  Except in the case of fraud or serious wrongdoing, the business owner is insulated from personal risk.

It is this limitation on liability which makes limited companies such an attractive proposition to business owners.  Sole traders and partnerships enjoy no such protection; there is no legal distinction between a sole trader business and its owner, and therefore, if the sole trader cannot meet its debts, the owner is personally responsible, and may need to sell their home or assets to clear their liabilities.  For many business owners with mortgages, families, and financial obligations, this personal risk is too great, making a limited company structure a better option. 

For this reason, it is imperative that sole traders have professional indemnity or public liability insurance in place to offer protection against potential litigation. These types of policies can be costly, so should be a consideration in deciding the right structure for your business.

Administrative Duties

Being a sole trader or partnership has some advantages, particularly when first starting up.  In terms of administrative burden and paperwork, sole traders simply need to complete and file an annual self-assessment tax return with HMRC – particularly beneficial if you are running your business on a part time basis while it grows.

Conversely, running a limited company attracts a lot of paperwork.  Among the responsibilities include holding an AGM and keeping meeting minutes, filing an annual confirmation statement, completing corporation tax and personal tax returns, maintaining a registered office, and submitting annual accounts.  Furthermore, the penalties for late submissions or incorrect statements can be severe.  Before deciding upon a limited company structure, it is important to consider how you will manage this administrative burden and put measures in place to meet regulatory requirements.


Sole traders have much greater flexibility in terms of when they can take money out of the business. Because there is no legal distinction between the owner and the business, drawings can be taken at any time and can be of any amount (as long as the funds are available).  Furthermore, sole traders keep all of their earnings after tax, so in a successful year, this can be a very lucrative model.  Conversely, in poorer performing years, they run the risk of not making enough money to earn a reasonable salary.

Directors of a limited company do not enjoy the same unfettered access to business funds, as they represent a separate legal entity.  Instead, as an employee of the business they can draw a salary, and take dividends when profits allow, but the dividends must be declared (more paperwork) and paid in proportion to shareholdings. 

As a general rule of thumb, businesses making an annual profit exceeding £25,000 are likely to benefit from the limited company model; earnings under this threshold may be better suited to a sole trader structure.


Another big advantage of running your business as a limited company is that you can legitimately pay less personal tax than a sole trader.  As a director/employee, you may choose to draw a salary which falls within your tax-free personal allowance, and then extract additional funds from the business in the form of dividends at a tax rate of just 7.5% (for a basic rate taxpayer).  In doing so, you will also minimise the employer and employee National Insurance Contributions (NICs) due as dividends are not subject to NICs. 

As a sole trader, not only is your entire income subject to employee NICs, but you will also pay income tax on your earnings (20% for a basic rate taxpayer).  Dividends (with their preferential tax treatment) are not relevant. 

From a tax perspective, as we said, a limited company is typically more tax-efficient than sole trader businesses for earnings in excess of £25,000 per annum (just a rule of thumb).

Professionalism and Brand

In some industries, operating a limited company carries credibility and is seen to be more professional.  Many larger organisations, and particularly those who select suppliers through competitive tender, will prefer to work with limited companies, severely restricting the ability of sole traders to win new contracts, particularly in the public sector.

Loans and Finance

It can be easier to secure personal finance and mortgages as an employee of a limited company than as a sole trader, although a good broker could usually find a way through any issues.  In terms of business finance, limited companies are typically a safer investment given their legal status as a distinct entity, and therefore it may be a little easier for a company to secure funding than it is for their sole trader counterparts.

Future Plans

In general, a limited company is a more flexible and attractive proposition than a sole trader business.  For example, it is easier to expand your business and offer shares to investors when you are a limited company than if you are a sole trader.  Similarly, if you choose to sell the business, a limited company is a more attractive proposition to a buyer than a sole trader structure.

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Blue Roof Accountants:  A Bespoke Service Tailored to Your Specific Needs

At Blue Roof Accountants, we give small business owners proactive, pragmatic advice on how to manage their company finances and reduce their tax burden.  From accounts preparation and corporation tax calculation, to personal tax planning and management consultancy, we work with company directors, sole traders, and entrepreneurs throughout Dorset to help them achieve maximum financial benefit from their business.

If you need straightforward advice from our experienced, friendly team, contact us today on 01202 532288.