Think Tank

Choosing between a sole trade/partnership and a limited company

When it comes to setting up a business, the choice between a sole trade or a limited company, or going into business with another party, as either a partnership or limited company, can make a significant impact. Each option has its unique advantages, and you should decide which option is best for you.

9th February 2024

The risks of going into business with others

If you do decide to go into business with another party (either as a partnership or limited company), rather than setting up as a sole trade or as a sole shareholder, you must ensure you are going into business with the right person as well as getting the structure right.

Having a business partner or multiple shareholders has its advantages as you share the cost of the start-up, share responsibilities, and work and support each other with tricky business decisions and motivation.

However, if you go into business with another you will not have total control over the business, decisions are shared, and differences of opinion can lead to disagreements. Profits are also shared so you need to agree at the outset what the expectation is on work and commitment and agree profit extraction terms in line with this.

Before going into business with another party, make sure you are comfortable working closely with them and share similar values on business, motivation, work habits and compromise. It is also important you communicate well with each other and respect and trust each other implicitly.

A shareholder agreement (if a company) or a partnership agreement (for a partnership) is critical to ensure each business partner is on the same page from the outset.

Sole trader / Partnership

Starting as an unincorporated entity, either a sole trader or partnership, is the quickest way to get your business off the ground. A sole trade is when you are running the business as an individual whereas a partnership is where you are running the business with others. These are easy to set up but comes with responsibilities. Here is what you need to know:

Registration. Any individuals involved must register for Self-Assessment with HMRC. If trading as a partnership, you also need to register your partnership with HMRC.

Tax returns. If trading as a sole trade, you need to prepare an annual Self-Assessment tax return which includes any profits made by the trade, as well as any other income you have. If trading as a partnership the partnership tax return will include any profits made by the trade, split between partners. Each partner’s share is then included on their annual Self-Assessment tax return as partnership income.

Taxation. Profits are taxed in the year they are earned, based on the agreed profit-sharing percentage for a partnership or 100% for a sole trader.

Ownership. The business and personal finances are intertwined, making partners or sole traders personally liable for business debts. In a partnership, partners are jointly and individually liable for the business activities of the other. If your partner disappears you will be liable for all debts, not just half of them.

Profits. These are fully yours, as soon as generated.

Cost efficiency. Accounting fees for partnerships are generally lower, saving you money.

Legal documents. If going into business with others and setting up a partnership you should put a partnership agreement in place outlining the way the business will be run, the responsibilities of each partner and documenting the profit split so you are all in agreement from the outset.

Limited company

Opting for a limited company creates a separate legal entity that offers more protection and flexibility:

Liability. The company is responsible for its financial difficulties, reducing the risk to shareholders’ personal assets. A limited company is legally separate from your personal affairs and in the event of any claims made against the company you have no personal liability. The exception to this is if personal guarantees are given, or you act unlawfully as some liability will still exist.

Profit extraction. You can take dividends (if profits allow) or a salary, or an optimum combination of the two, offering greater tax efficiency. There is also the option for pension contributions etc.

Taxation. The company pays Corporation Tax on profit generated, typically 9 months after the financial year end, which can be set at any month of the year.

Ownership. Ownership is defined by shares, allowing for clearer equity distribution. Any profits after salaries extracted remain the company’s (rather than yours) until dividends are declared.

Legal documents. Certain documents need to be prepared for a company including articles of association, board minutes, etc. We can help with this. A further key document we recommend is a shareholder agreement which should be approved and signed by all shareholders and cover how the business will be operated and document shareholders’ rights and obligations, so all are treated fairly.

Compliance. Expect a bit more compliance work, but the added protection can be worth it.

Which to choose?

The key difference between the two options is risk.

A limited company shields personal assets in the event of debt, losses, or legal claims as it is legally separate from your personal affairs, unless personal guarantees are given, or you act unlawfully. A limited company is, therefore, significantly less risky than an unincorporated entity, but there are more administrative and compliance tasks to undertake.

There is significantly more tax planning you can do with a limited company, rather than being fully taxed on all profits as they arise, and with the right strategies, you can enjoy tax advantages as a result.

Quick guide table
Sole Trade or Partnership Limited Company
Setup simplicity Simple and quick to establish. More complex setup process.
Registration Register partnership and/or self-assessment with HMRC. Register the company with Companies House.
Taxation Profits are 100% taxed at an owner level, split for a partnership using a profit-sharing agreement. The company pays corporation tax on profits (after salaries but before dividends).

Shareholders are then taxed on monies extracted via dividends or salaries.

Ownership Sole trader or partners are the owners; equity is not defined by shares. Ownership is defined by shares, allowing for clear equity distribution.
Liability Partners/sole trader are personally liable for all business debts. If a partner disappears the other partner(s) will be fully liable. Limited liability, reducing personal risk to shareholders’ assets.
Profit extraction Business profits can be taken by the sole trader at any point. Partners can take their share of profits, as per the agreement, at any point. Options for profit extraction include dividends and salaries.
Tax efficiency Limited tax planning opportunities. Greater tax planning flexibility.
Ownership agreements If operating as a partnership, get a partnership agreement in place so you are all on the same page. If more than one shareholder, get a shareholder agreement in place to ensure shareholders are treated fairly.
Compliance Fewer compliance requirements. More compliance work, including board minutes, etc and some additional legislation to follow e.g. Companies Act.
Privacy Financial results not visible in public domain Some financials visible on the public record
Accounting fees Generally lower accounting fees. Slightly higher accounting fees.
Risk Higher personal risk for owner(s). Reduced personal risk, with the company as a separate entity.
Flexibility Limited in terms of structure and equity distribution. More flexible in terms of business structure and ownership.

Action points
  1. Evaluate your risk tolerance.
  2. Consider your long-term business goals.
  3. If with a business partner, ensure they are the right fit and the right person to go into business with.
  4. Consult with a financial adviser for personalised guidance.
  5. Decide whether the simplicity of a sole trader or partnership or the protection of a limited company aligns with your vision.

The decision should not be taken lightly or without consideration.

Get in touch

If you want to explore this further, or any other financial matter, please get in touch with your usual Old Mill contact or click here