Sole trader, partnership or limited company?

This briefing note is designed to set out the key differences and help you decide, at a glance, what legal structure is best for you. 

We also strongly recommend that you speak to an accountant as they will be able to advise you on the tax implications and benefits of each structure.

Sole trader

A sole trader is essentially a self-employed person who is the sole owner of a business. It is the simplest business structure, with approximately 3.5 million sole traders in 2020, making up around 60% of all small businesses in the UK. 

To set up as a sole trader, you need to tell HMRC that you pay tax through a ‘Self-Assessment’. You will then need to file a tax return every year to declare your earnings. You will be responsible for all the earnings and losses of the business and need to keep a record of all sales and expenses. 

There are several advantages and disadvantages; however, two of the main ones are:

Advantages:

• Easy to set up and relatively little paperwork.
  
   
• Greater privacy without the need to file documents (such as accounts) at a public registry. 

Disadvantages:

• Sole traders have unlimited liability, as they’re not viewed as a separate entity by UK law. This means that if the business gets into debt, the business owner is personally liable. 
  
   
• Raising finance can be tricky, as banks and other investors may prefer a more formal legal structure.

Partnership

A partnership is one of the oldest forms of business arrangements and predates the development of company law. It is formed when two or more people agree to join together in a business venture with a view to making a profit. Therefore, it is common for individuals to accidentally form a partnership, which is then governed by The Partnership Act 1890. For more information on how this legislation may affect you, please read our guide to why your business should have a partnership agreement.

In a traditional partnership, all partners own the business and are responsible for any profits or liabilities on an equal basis. A partnership has no separate legal personality from its partners and cannot own assets in its own name (for example, property or machinery). Its partners are subject to income tax and are taxed individually as if they were sole traders.

There are countless advantages and disadvantages; however, two of the main ones are:

Advantages:

• Flexibility - it does not have prescribed director and shareholder roles in the way that limited companies do, which can allow agreater degree of flexibility with management and operations.
  
   
• Lack of formality - there are no registration requirements (although we strongly recommend a partnership agreement).

Disadvantages:

• Each partner is ‘jointly and severally’ liable for the partnership’s debts; that is, each partner is liable for the partnership debts.

• Individuals can create a partnership without knowing, and there is a risk of disagreements and friction among the partners without a formal agreement.

Limited company

A limited company is a type of business structure with its own legal identity, separate from its owners (shareholders) and its managers (directors). There were two million limited companies formed in 2020, making it the second most popular legal structure.

A limited company is governed by company law and a constitution, normally referred to as articles of association. Articles of association are effectively a written rule book that documents how the company should be run.

This is a public document filed at Companies House, which anyone can inspect. Some limited companies also have a separate shareholders’ agreement, which regulates the relationship between the shareholders (owners). This document does not always need to be filed at Companies House and therefore has the benefit of being confidential.

For more information on why a company would have a shareholders’ agreement and why it is recommended, please read our guide on shareholders’ agreements.

One of the biggest advantages of having a limited company is that the company has limited liability. This means that, unlike sole traders and partnerships, a company is a legal entity separate from both its owners (shareholders) and those people who run it on a day-to-day basis (the directors).

This means that the company can acquire assets and incur liabilities in its own name, which are separate from the shareholders' own assets and liabilities. Therefore, this means that if the company goes into debt, the owners' assets are protected. It also means that legal action (in most cases) would be brought against the company and not the individuals.  

There are many advantages and disadvantages; however, two of the main ones are:

Advantages:

• Unlike the sole trader structure, a limited company is a legal ‘person’ in its own right, with an entirely separate identity from its owners and directors. As a result, companies can enter into contracts in their own name and are responsible for their own debts and liabilities.
  
   
• Generally speaking, companies have access to more lending opportunities than sole traders, and certain banks will only lend to incorporated businesses.

Disadvantages:

• Limited companies must be incorporated at the public registry, i.e. Companies House and are required to file certain documents on an annual basis (e.g. annual accounts). There are penalties for failing to comply with the relevant deadlines. 

• More complicated to set up and run. Will often require specialist advice from solicitors and accountants.

Comparison

Conclusion

When starting a business, it is key to decide and understand which legal structure is best for you. Each structure comes with its own unique set of advantages. It is important not to rush into a decision although it is possible to change structure during the life of the business.

For more information about the different types of legal structure, please contact Hamed Ovaisi or get in touch via our online enquiry form. 

Our team of solicitors in Brighton, Eastbourne, London, Hastings and Uckfield can help you understand your options.