Sole trader vs limited company: which structure is right for you?

If you are starting a business or wondering whether to incorporate, the choice between sole trader and limited company affects your personal risk, your tax, your paperwork and how you borrow. The core legal difference is that a limited company is a separate legal entity from the people who own and run it, while a sole trader is not. Most of the practical differences covered below, from liability for debts to how lenders assess an application, follow from that one point.

This guide pays particular attention to how each structure affects borrowing, because that is where Smart Funding Solutions, a commercial finance broker, sees the difference day to day. We are not legal or tax advisers, so speak to an accountant before you decide. GOV.UK has an official overview of business legal structures. If you are weighing up a partnership model instead, see our guide to limited companies and LLPs.

01Sole trader vs limited company at a glance

	Sole trader	Limited company
Legal status	You and the business are the same	Separate legal entity
Liability	Unlimited: personal assets at risk	Limited to your investment (subject to personal guarantees)
Tax on profits	Income Tax and Class 4 National Insurance	Corporation Tax; directors pay tax on salary and dividends
Registration	Register with HMRC for Self Assessment	Incorporate at Companies House
Annual admin	Self Assessment tax return	Accounts and confirmation statement at Companies House, Corporation Tax return, payroll
Privacy	Accounts are private	Accounts and director details are public
Set-up cost	Low	Higher, plus ongoing accountancy costs

02Being a sole trader

This is the simplest way to run a business in the UK. You register with HMRC for Self Assessment, keep records of income and expenses, and pay tax on your profits through your annual return.

Advantages of being a sole trader

• Simplicity: quick to start, with minimal paperwork.
• Low costs: no incorporation and usually lower accountancy fees.
• Control and privacy: you make all decisions and your accounts are not published.
• Flexibility: you can adapt quickly and keep all profits after tax.

Disadvantages of being a sole trader

• Unlimited liability: your home and savings could be at risk if the business cannot pay its debts.
• Tax at higher profits: all profit is taxed as your income, whether or not you withdraw it.
• Funding: some lenders and investors prefer limited companies, and equity investment is not possible.
• Growth: bringing in partners or investors means changing structure.

Sole trader tax

You pay Income Tax on profits above your Personal Allowance, plus Class 4 National Insurance. You can deduct allowable business expenses. Tax is paid through Self Assessment, with payments on account if your bill exceeds HMRC's threshold. You must register for VAT if your taxable turnover passes the VAT threshold.

03Running a limited company

You incorporate the company at Companies House, appoint at least one director and issue shares. The company pays Corporation Tax on its profits, and you are paid through salary, dividends or both.

Advantages of a limited company

• Limited liability: company debts are the company's, not yours, unless you give a personal guarantee or act wrongfully.
• Tax planning: a mix of salary and dividends, and the ability to leave profits in the company, can be more tax-efficient at certain profit levels.
• Professional image: some clients and larger customers prefer to deal with companies.
• Investment: you can sell shares to raise capital.

Disadvantages of a limited company

• More admin: annual accounts, confirmation statements, Corporation Tax returns, payroll and statutory registers.
• Higher costs: accountancy fees are usually higher.
• Public information: accounts and director details appear on the public register.
• Directors' duties: legal responsibilities to act in the company's interests.
• Shared control: if others hold shares or directorships, decisions may be shared.

Limited company tax

The company pays Corporation Tax on profits. Directors pay Income Tax and National Insurance on salary, and dividend tax on dividends. The company must register for VAT if its taxable turnover passes the threshold. Rates and allowances change, so check the current figures with your accountant or on GOV.UK.

04How your structure affects borrowing

• Sole traders borrow in their own name, so personal credit history matters most. Finance of £25,000 or less can be regulated consumer credit, bringing extra protections. See sole trader loans.
• Limited companies borrow in the company's name and build a business credit profile. Lenders still check directors' credit and usually ask for personal guarantees, so limited liability does not always protect you from business borrowing. Our page on limited company business loans explains how lenders assess companies.
• Trading history: if you switch structure, some lenders treat the new company as a new business, although others will consider your sole trader history.

05How to choose between the two

1. Goals: a small, steady business may suit sole trader status; ambitious growth or outside investment points to a company.
2. Risk: how comfortable are you with unlimited personal liability?
3. Admin: are you willing to take on company filing and payroll?
4. Tax: ask an accountant to compare your likely tax under each structure.
5. Customers: do your clients expect to deal with a company?
6. Future flexibility: you can start as a sole trader and incorporate later.

06Switching from sole trader to limited company

1. Take advice from an accountant on tax and timing.
2. Check your chosen name is available and register the company at Companies House.
3. Open a business bank account in the company's name.
4. Transfer assets, contracts and liabilities to the company, with legal advice where needed.
5. Set up payroll if you will draw a salary, and register the company for Corporation Tax (and VAT if required).
6. Tell HMRC you have stopped trading as a sole trader and file your final Self Assessment return.
7. Inform customers, suppliers and lenders, and update invoices, website and stationery.

Whichever structure you choose, we can approach lenders that work with businesses like yours and review their terms with you; the lender makes the final decision. Speak to a business finance broker about your options.