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Growing a business is a very exciting prospect. Once that first hurdle; of moving from employed to self-employed, is passed, one of the next milestones comes in the transition from a self-employed Sole Trader to a Limited Company.
Why would you want to change to a Limited Company?
1 – Limited liability
The first benefit is made clear by the title for the type of Company: limited refers to the level of liability represented by the Company Directors. Importantly, it is very different from the full liability level of a Sole Trader.
The law makes no distinction between the individual and the Sole Trade business itself, meaning a mistake or problem that is the responsibility of the business is equally a direct and full responsibility for the individual.
Essentially, this means that any Sole Trader debt is also viewed as personal debt; that any legal claims for compensation on the business would also be claims against the individual
Bankruptcy for a Sole Trader business is also a bankruptcy for the owner. This is not the case with a Limited Company.
With incorporation comes a separation between the individual and the business – even if the individual remains the sole employee of the business. There is no longer the fear that personal assets (for example, your home) are at risk due to business-related activities.
2 – Corporation tax vs. income tax
The tax structure for limited companies is quite different to that of a basic self-employed Sole Trader. The most significant difference is that a Limited Company pays corporation tax on profits, rather than income tax. Under the current Conservative government, corporation tax is a significant advantage when compared to income tax and currently stands at 19%.
Compared with the basic income tax rate of 20% and the higher rate of 40%, corporation tax represents a saving of many thousands of pounds to many business owners.
There are other tax benefits to being a Limited Company, with a wider range of allowances and planning opportunities available.
3 – Legitimacy
Businesses live and die by their reputation. Incorporating to become a Limited Company can increase your legitimacy in the eyes of many prospective clients and open the door to a wider range of business options. Indeed, many larger businesses have a policy against working with Sole Traders due to feared instability and long-term support.
Not only that, but your business name is registered with Companies House, identifying you and protecting you from copycats This can often help, especially if you work in a crowded marketplace, offering a level of protection and branding identity beyond the simple level of a Sole Trader. You no longer have the worry that someone is trading under the same name, damaging your business.
4 – Funding
Many funding partners are unwilling to enter into agreements with Sole Traders, seeing investment often as simply putting the money directly into the pocket of the self-employed individual rather than it being distinctly banked by the business and under greater levels of scrutiny and protection from fraud.
If you are looking for external investors to help your business grow, then it would be wise to consider forming a Limited Company beforehand.
5 – The lure of shares
Ownership of a Limited Company is made up of several Shareholders, each of whom owns a portion of the Company. Offering shares, and thus a ‘cut of the pie’ to prospective employees as an extra incentive beyond salary is an excellent way to increase productivity and loyalty. This will also provide you with something to offer when the current level of financial strength in the Company isn’t enough to entice the top talent.
Many people have accepted positions in limited companies with a tiny salary but with an alluring shares package and have gone on to help grow those companies into strong institutions, realising their investment fully.
Understanding Directors and Shareholders
Unlike when working as a Sole Trader, a Limited Company is made up of Shareholders and Directors – the people (and in some cases, other companies) that own and manage the Company.
It is important to understand that Directors can be Shareholders and vice versa, and that also a person can be just a Director or just a Shareholder. Being appointed as either isn’t a limitation.
Company Shareholders
Shareholders (also known as ‘members’) are the owners of the Company. Each Limited Company’s ownership is divided into multiple shares which, when combined, total 100% of the Company.
It is possible to have sole ownership of a Limited Company, considered to be a single Shareholder with 100% ownership. Often a Sole Trader moving to Limited Company status will begin in this way.
Shareholders:
- can be either an individual or a corporate body;
- are limited in liability to a portion equal to their share;
- receive a portion of the profit equal to their share percentage (dividends);
- are not involved with the business management or activities unless also Directors; and
- have voting rights and power over significant issues equal to the percentage of their share (can depend on the type of shares as determined by the Prescribed Particulars).
Company Directors
Also known as Company Officers, the Directors are the top-level employees responsible for running the Company.
In a new Limited Company grown from a Sole Trader, it is likely that the only Director will also be the owner, however, as the Company builds, it will become necessary to appoint additional Directors to take on some of the demands of running the business.
Unlike Shareholders, there must always be at least one human Director in a Company. There is no need for a Director to also be a Shareholder.
Directors:
- can be either an individual or a corporate body;
- are appointed by the Shareholders;
- are responsible under the Companies Act 2006 and the Articles of Association to manage the Company lawfully and ethically;
- promote the success of the business making a profit for the benefit of the Company and its Shareholders;
- are an employee and receive a salary;
- are legally responsible for filing true and fair annual accounts, Annual Returns and Company Tax Returns by the statutory deadlines;
- are responsible for paying all Company taxes on time.
What are the disadvantages of a Limited Company?
Of course, while there are many benefits of incorporation, it isn’t right for everyone. Many small businesses find the additional legal structure and paperwork an extra burden they would rather not shoulder, others don’t reach a level of turnover to make the financial benefits valuable enough to make the move and some just don’t get the fact that the Company and they as an individual are two separate legal entities, struggling to manage their Directors’ Loan Account.
One of the other legal ramifications of becoming a Limited Company includes a level of transparency that may not be appealing. Limited Company accounts are published on the Companies House website and information regarding Directors and Shareholders is publicly available for all to access.
At Black and White Accounting, we can discuss your current structure and help you determine when it is best to make the move to a Limited Company. We will look at your accounts in detail, and discuss the options with you in full, from the various tax structures to the fees associated with business bank accounts.
The process of changing from Sole Trader to Limited Company
It is relatively easy to convert from a Sole Trader to a Limited Company with our help. Black and White Accounting can undertake most of the process for you. As your Accountant, we will register all the required paperwork with HMRC, Companies House and all other appropriate taxes for the new Company. You can also use our address to ensure your personal address is not in the public domain.
What you will need to do is choose a suitable Company name – it’s something you are going to be working with for many years, so make sure you go with a name you are happy with, that represents who you are as a brand and (most importantly) isn’t already taken, or protected! The hardest part is setting up a bank account, but thankfully there is some improvement in this space.
The role of an Accountant in a Limited Company
With the increased paperwork, declaring dividends and paying you through a proper payroll system, there is more need for an Accountant when running a Limited Company than there is for a Sole Trader.
While this cost is offset against corporation tax and is likely to be far smaller than the gains made in moving to a Limited Company model, it is still something that you should consider before making your final decision.
We believe in transparency at Black and White Accounting and will discuss our role alongside the other benefits of becoming a Limited Company to ensure you make your decision with complete understanding. The relationship between the Accountant and the major Shareholders and Directors in a Limited Company is an important one; we will help you to pass this milestone smoothly and move into another great period of stability and growth for your business, with us as your business partners every step of the way.
Limited Companies and the Coronavirus Crisis
Now it would be pertinent to add here that there is some frustration with the level of support Directors of Limited Companies have received as part of the Coronavirus Support Schemes, in what appears to be a deliberate act of the current Government. However, the advantages of being a Limited Company are still significant for a lot of Sole Traders.
Black and White Accounting and your Limited Company
If you are earning over £35,000 as a Sole Trader, then you may find an advantage in moving to a Limited Company today and that’s just for tax reasons. There are several other reasons which could make this an attractive structure for you and your business. Some people choose to go directly to a Limited Company when they start up a business, such are these advantages.
For help from us here at Black and White Accounting, get in touch today; please email, fill out our contact form or phone us on 0800 140 4644 and one of our expert team will be on the other end ready to help you. We look forward to hearing from you!
