Sole trader versus limited company: the pros and cons

When you start out in your own business, it’s common to be a one-person operation. You’re in charge of your accounts, your marketing and everything that relates to the service you’re providing. You’re the one answering the phone, replying to all the emails and even making the cups of tea.

So, does that mean that going into business is the same as being a sole trader?

Well, no, not necessarily. It’s also possible to start a new business venture by setting up as a limited company.

In this article, we’ll take a look at what it means to be a sole trader or a limited company. And we’ll show you some of the positives and negatives of each approach so that you can make the best decision for you.

We’re not here to say that one approach is better than another. We know that what’s right for some isn’t right for others. It all comes down to your circumstances and how you want to run your business.

If you need help understanding the options, get in touch to catch up over a cup of coffee with us. That way, we can cut through the theory and answer the questions that are relevant to your situation.

Let’s start by looking at the terms ‘sole trader’ and ‘limited company’ so that we’re clear about what we mean.

What does ‘sole trader’ mean?

A sole trader is someone who is formally recognised by HMRC as being in business for themselves.

It’s common for such people to refer to themselves as self-employed or as freelancers, but the official term is ‘sole trader’.

When you register with HMRC as a sole trader, you must agree to keep appropriate financial records and pay all taxes due. This means tracking eligible expenses, issuing invoices for all work done and submitting self-assessment returns that confirm your taxable income.

Unlike being a traditional employee of another organisation, where tax is usually deducted at source through the Pay As You Earn (PAYE) scheme, sole traders use self-assessment to calculate their tax burden and pay this to HMRC twice a year.

In addition to these tax payments, sole traders usually need to pay Class 2 and Class 4 National Insurance Contributions (NICs). The amounts are calculated automatically when you submit your self-assessment form online. You can find out more about this on the government’s Self-employed National Insurance rates page.

What does ‘limited company’ mean?

A limited company has its own legal identity and is structured as a business that has shareholders and directors.

A limited company can be run by just one person, but the setup is more involved than being a sole trader.

For limited companies run by an individual, the person in question becomes the director of the company as well as its only shareholder. That person then takes their remuneration in the form of either a salary or dividends or a mix of both from the earnings of the business. How to remunerate yourself can be complex, but we can remove the complication.

To set up a limited company, you need to register with Companies House. That means your full name, address and date of birth, well at least month and year will be published for all to see. The same is true for all directors in the UK, even for those who serve as directors in not-for-profit organisations.

When registering as a limited company, you must agree to file an annual confirmation statement and annual company accounts, both these documents are on the public record.

Sole Trader versus Limited Company: What are the differences?

We can understand the differences by looking at some of the positives and negatives associated with being a sole trader versus setting up as a limited company.

Sole Trader

✅ It’s easier to set up as a sole trader

Perhaps that’s why there are approximately twice as many sole traders as there are limited companies in the UK.

There’s less paperwork associated with being a sole trader (though you still have to complete an annual tax return), and you don’t need to register with Companies House.

✅ Sole traders have a greater level of privacy than limited companies

If you set up a limited company, some of your personal details will be published in the records of Companies House.

However, that doesn’t mean that sole traders are anonymous. Remember that you’ll need to put some information out into the public domain if you’re to market your business effectively.

❌ Sole traders have full liability if their business gets into debt

In extreme cases, business debts for sole traders can lead to the loss of personal assets.

It’s possible to protect yourself from such things through the likes of professional indemnity insurance and payment protection insurance, but keep in mind that liability for your sole-trader business ultimately lies with you.

❌ Sole traders may be at a disadvantage when bidding for big contracts

Perceptions matter and your business status can have an influence on whether clients want to hire you.

Even if you’re providing exactly the service a client is looking for, their internal policies may rule you out because you’re a sole trader and they’ve decided to work only with limited companies.

This means that it’s useful to understand who your ideal clients are and what matters to them. If the majority of your prospective clients are likely to do business with you only if you run a limited company, then setting up as a sole trader might not be a wise choice.

But if this consideration isn’t likely to affect your clients’ decisions about working with you, perhaps being a sole trader could give you some advantages over your competitors and therefore make you a more appealing choice for your clients.

❌ Sole Traders may not be eligible to claim tax reliefs

You have to be within the charge to corporation tax to be eligible to claim Research & Development tax reliefs and the creative industries tax reliefs. Therefore in order to claim these reliefs, you have to be a limited company.

Limited Company

✅ Limited companies may feel more trustworthy to some clients

A limited company can give the impression of a greater sense of permanence and financial success, and that can influence clients to favour working with a limited company over a sole trader.

✅ Limited companies have limited liability

Financial liabilities are placed on the company rather than on the individual(s) running the company. Generally. that means your personal assets aren’t at risk if you run a limited company.

✅ Limited companies can be more profitable for some businesses

As your earnings increase, it can be financially advantageous to operate as a limited company rather than as a sole trader.

Limited companies pay corporation tax rather than personal income tax, and you have far more flexibility in terms of how you remunerate yourself, affording you more tax planning opportunities. have the potential to save more than sole traders by taking advantage of a greater range of tax-deductible items.

Those who plan for gradual growth sometimes start a business as a sole trader and then switch to becoming a limited company. We mention this to make clear that your choice isn’t fixed – you can change your mind and business owners often do.

✅ Limited companies have greater protection over their names

Setting up a limited company with Companies House means that your business will be the only one allowed to register and use the name you’ve chosen.

Note that you may still need to apply for a registered trademark if that’s relevant to your business.

Sole traders aren’t offered this sort of naming protection, because you can’t legally prevent someone else with the same name from using that name in their business.

❌ Limited companies mean more paperwork and financial expertise

It takes more effort to set up a limited company, and the ongoing reporting requirements are more onerous. An annual confirmation statement and annual company accounts must be filed for all limited companies.

While a sole trader can often handle their own accounts without external help, it’s often advisable for limited companies to engage an accountant to keep their finances in order.

There’s no way for us to know what’s the right choice for your situation, though we’re happy to talk with you about your questions and concerns so that you can put your mind at ease. Get in touch to book a Discovery Call and we’ll sort out the rest.

A quick note about VAT

Whether you register as a sole trader or a limited company, you also need to consider the separate question of whether to register for VAT.

VAT registration is compulsory if your business’ annual turnover exceeds the VAT threshold. Find out more in our article about VAT.

Next steps

We hope we’ve helped you understand the essence of what it means to be a sole trader or a limited company. But what if you still need some more guidance to help you make the right choice for your business?

That’s where we’re on hand to listen to your questions and give you the answers you need to make an informed decision.

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