Self-employed vs limited company: What’s right for your new business?

So, you’re ready to take the plunge into entrepreneurship and start your own business. The next major decision is choosing the business structure that you’re going to operate with.

In the UK, the two most popular options are to go the self-employed route or to form a limited company. In this article, we look at the self-employed and limited company structures and highlight the pros and cons of each. Let’s get started.

Self-employed: A quick explanation

As a self-employed individual, you will generally be referred to as a sole trader (or sole proprietor). Under this model, there is no separation between you and the business itself – you are, essentially, the same legal entity. 

Self-employment is a popular option for many people taking the first step in working for themselves. In 2023, there were around 4.24 million self-employed workers in the UK.

To set up as self-employed, you must register directly with HMRC.

Limited company: A quick explanation

Limited companies are run by directors and owned by shareholders (a company can be operated with several people sharing these roles or just one person taking it all on). As a limited company, there is a clear difference between the individuals involved and the company. 

According to Companies House (the UK’s registrar of companies), between July and September 2023, 219,254 new companies were incorporated in the UK. In total, at the end of September, there were 5,213,416 companies on the total register.

To set up a limited company, you can either register directly with Companies House or use a third-party specialist such as 1st Formations.

The pros of being self-employed

So could being self-employed be right for you? To help you decide, here are five pros.

1) Speedy start-up

Whilst registration with HMRC is compulsory, you can actually start trading before you complete the registration process (which itself is quick, simple, and free).  

You will need to set yourself up as self-employed (also known as a sole trader) with HMRC if:

  • You earn more than £1,000 from self-employment in a tax year (6 April to 5 April)
  • You need to prove you’re self-employed (for example to claim Tax-Free Childcare)
  • You want to make voluntary Class 2 National Insurance payments

2) You have minimal admin

Other than the administration involved in the day-to-day running of your business, the only admin you need to take care of is sending in a Self Assessment tax return.

While you may not have many admin requirements, it’s important to keep business records and records of any expenses. You will also need to save up for tax, as it’s not deducted at source; instead you will pay it after submitting your tax return.

Not sure how much you need to save for tax? You can budget for your Self Employment tax bill using this handy HMRC calculator.

3) Payday is when you want

Your business’ money is your money so you can use it for what you want, when you want. Although, you need to ensure your business can pay its bills, and you can pay your tax bill. This is where being aware of your outgoings (expenses) and how much you will need to save for tax and National Insurance is important.

4) You can do business in private

Your financial information is kept private, meaning it won’t be published anywhere. When you are a limited company, some information is public knowledge with a limited company. This includes:

  • Names, dates of birth and contact addresses of directors
  • Details of people with significant control (PSCs)
  • Your accounts (and whether or not they have been filed on time)
  • Your registered offices
  • Any outstanding charges, such as mortgages on properties owned by the company

5) You have the flexibility to go bigger

If business is going well, you can expand into a limited company, which is a relatively simple process. How do you know when the right time to move to a limited company is? As a rough rule of thumb, it can be more tax efficient to incorporate your business once you earn over £30,000 a year in profit.

You may also want to protect your business name/brand, attract larger clients, or limit your liability at some point. If so, becoming a limited option may be the right option for you. If you are a freelancer or contractor, you might find that being a limited company enables you to quote for more contracts.

The cons of being self-employed

And here are five cons of being self-employed.

1) Business debts are your debts

Because there is no legal distinction between you and the business, you are personally liable for any business debts. This means you will need to pay them yourself, and if you do not, your creditor can take action against you. If they do, your business and personal assets could be at risk.

2) Questionable tax efficiency

This will always depend on circumstance but typically, the self-employed/sole trader business model is not a tax-efficient one.

The good news is that, as long as your profits (and any other earnings) don’t go over your annual personal allowance (£12,570 a year for 2022/23), you won’t pay any income tax. You also don’t need to pay any National Insurance Contributions (NICs.

However, your tax bill starts to climb once you start paying income tax and self-employed NICs. Compare the 20% or 40% income tax you pay on profits as a sole trader to the 19% corporation tax for small limited companies, and going limited starts to look like an attractive option.

3) You can give off an amateur impression

Self-employed individuals are sometimes perceived to be ‘small-time’, which can make it hard to appeal to customers and grow your business. This can also restrict you from some freelancer contracts when working for larger companies.

4) Investment challenges

If you are considering expanding or seeking investment, being a sole trader will count against you. Attracting investors can be tricky because of the perceived size of your operation, and because they can’t be rewarded with a stake in the business through shares.

5) Selling the business isn’t easy

And finally, the lack of separation between you and the business can complicate matters if you ever decide to sell up.

As a sole trader you can’t sell your right to own your business – you can only sell your company’s assets. Once someone has bought these assets, your sole proprietorship dissolves and the new owner will need to create a new business structure.

The pros of running as a limited company

It might be that running as a limited company is a better choice for you. To help you decide, here are five pros.

1) Your finances are protected

The ‘limited’ in ‘limited company’ means ‘limited liability’ – if the company accrues debts, your personal finances are safe, unlike a sole trader. The exception to this is if you have an overdrawn director’s loan account (if you have borrowed money from your company and not paid it back).

2) It’s tax-efficient

This will depend on your circumstances but the limited company structure is more heavily associated with tax efficiency when compared to the self-employed model. See here for more detail as to why.

3) You’re more esteemed

The limited company model is one of the most well-known in the world and can give your business a competitive edge, especially when compared to sole traders.

4) You have greater brand protection

Company names must be unique and can’t even be similar to another name on the Companies House register, so when you form a company, you are locking down your company name.

If you’re not quite ready to become a limited company yet but want to protect your name and stop someone else using it, you can incorporate a company but then leave it dormant. This will keep your name safe until you’re ready to go limited.

5) It makes succession planning easier

Because limited companies and their owners are legally distinct, selling on (or passing on) a company can be a simple process. If wish to sell your ownership of your limited company, you have two choices:

  • You can chose to sell your shares in your business (if there is more than one owner, they must all agree to the sale).
  • Or, you can sell your company’s assets to a new owner instead. These might include equipment, furniture and fixtures, inventory, property and investments. 

Whichever way you choose, selling your shares or assets transfers all company liabilities to the new owner. This includes outstanding debts and loans, salaries and taxes.

The cons of running as a limited company

And here are five cons of running as a limited company.

1) Registration with Companies House is necessary

The company formation process could be considered complicated. Nonetheless, with the assistance of a company formation such as 1st Formations, it is still quick and simple.

2) You have filing obligations

There is more paperwork involved when you are a limited company. You must file annual accounts, confirmation statements, and tax returns. Plus, Corporation Tax should be paid on time and any company changes must be done in a compliant way.

Most limited companies hire accountants to prepare their annual accounts as they are more complex than completing a Self-Assessment tax return. While this is an extra expense, it can be a wise investment as your accountant should advise you of potential tax efficiencies.

3) You have a legal responsibility

You are legally obliged to ensure that the company meets all of its filing requirements. Failure to do so can result in high penalties and companies being removed from the register.

It is also a requirement to have a separate business bank account. However, while not legally essential, this is a good idea anyway if you are self-employed to make bookkeeping easier.

4) You need processes for payday

Money can only be withdrawn from the company as a dividend payment, a director’s loan, or as expenses – it’s not a simple case of just popping down to the cash machine and paying yourself.

5) Company information is public

As a limited company, information about you and your business is published on the public register, including director and shareholder names and financial information.

Which is right for you: self-employed or limited company?

As we have just highlighted, there are advantages and disadvantages to the self-employed/sole trader model and the limited company model. 

What’s right for one business will not be appropriate for another. However, because of the financial protection that a limited company provides its owner(s), running as a company is generally the ‘safer’ option. Plus, as sole trader businesses do become more successful, they often end up registering as limited companies anyway.

We hope this article has proven useful in helping you make the right decision for you and your new business.

About the author

Kate Moss-Robins is a Content Writer at 1st Formations.

1st Formations have helped register more than 1 million UK limited companies. If you have decided that a limited company represents your best route into entrepreneurialism, they can help from only £12.99. Their company formation process is entirely online and you could be ready to trade in as little as 3-6 hours. Take a look at their company formation packages now.