Should I become a limited company?

One of the first significant decisions any new business owner faces is choosing a legal structure. For many, this means weighing up whether to operate as a sole trader or incorporate as a limited company. This decision can have lasting implications affecting tax efficiency, personal liability, and administrative responsibilities, so it’s crucial to understand the pros and cons before proceeding.

Our guide to incorporation for business owners will help highlight some advantages and disadvantages of forming a limited company and provide practical advice to determine whether it’s the right move for your business.

Should I become a limited company?

It depends on your circumstances. Incorporation offers clear benefits such as limited liability and potential tax advantages, but also comes with additional responsibilities and visibility. The right choice depends on your business goals, income level, and appetite for administration.

Pros: Why should you become a limited company?

Incorporation protection (limited liability)

When you incorporate, your business becomes its own legal entity. This means your personal finances are generally protected if the business faces financial difficulties. The risk is usually limited to the value of the shares you hold, unless personal guarantees are made.

Taxation efficiency

Trading through a limited company can be more tax-efficient than operating as a sole trader, especially if you don’t need to draw all your profits immediately. Profits retained in the company are taxed at the Corporation Tax rate (which is often lower than Income Tax rates). With careful planning, including the use of personal allowances and dividends, you can reduce your overall tax burden.

Alphabet shares

You can issue different classes of shares (e.g. A, B, C shares) to family members, allowing each shareholder to receive dividends at different levels. This can be a powerful tool for income splitting and tax planning, provided it’s done within the rules.

Brand protection

Once incorporated, your business name is registered with Companies House and protected by law. No other company can register a name that is identical or considered too similar, providing you with brand security.

Professional image and customer confidence

Being a limited company can enhance your credibility. Some clients, especially larger organisations, prefer or require suppliers to be incorporated. Publicly available company information (such as financial statements and directorships) can give customers additional confidence in your legitimacy and stability.

Investment opportunities

It is generally easier for limited companies to raise external investment. Investors often prefer limited companies because of their defined share structures, liability limitations, and formal governance.

Cons: Why shouldn’t you become a limited company?

Appearing on the public record

When you incorporate, key details about your business, such as directors’ names, shareholders, and company accounts, must be filed with Companies House. While some information (e.g., home addresses) can be protected, your financial and structural data is available to the public.

Administration costs and compliance

Running a limited company involves more paperwork and costs. These may include: incorporation fees, registered office and company secretarial costs, annual Confirmation Statement (CS01), preparation and filing of statutory accounts and Corporation Tax returns.

Complex tax rules for some

If you’re operating as a personal service company (e.g., providing services to a single client through your limited company), you may fall within the scope of IR35. This legislation can reduce or eliminate the tax benefits of incorporation and may leave you better off as an employee.

Less flexibility with profits

Unlike sole traders who can draw funds freely, limited company profits can only be extracted as salary, dividends or loans, each of which has specific tax rules. This adds a layer of complexity to your cash flow planning.

How to decide if incorporation is right for you

Use the following framework to help guide your decision bearing in mind, it’s always best to seek professional advice:

Example scenarios:

Better to incorporate: You’re generating £80,000+ in profits and only need £40,000 to live on. Leaving the rest in the company and taking dividends over time offers tax advantages.

Better to stay sole trader: You’re self-employed with a single contract earning £25,000/year and want simplicity with minimal admin.

How do I become a limited company?

Steps to incorporation:

1. Choose a company name – Must be unique and comply with Companies House naming rules.
2. Decide on company structure – At least one director and one shareholder required (can be the same person).
3. Register with Companies House –is usually processed within 24 hours and best done via professional companies to ensure accuracy.
4. Register for Corporation Tax with HMRC – You must do this within three months of starting to trade.
5. Set up a business bank account – Required to separate personal and company finances.
6. Meet ongoing obligations – File annual accounts, Confirmation Statements and pay taxes on time.

FAQs

Can I change from sole trader to limited company?

Yes, many businesses start as sole traders and incorporate once they grow. You’ll need to inform HMRC and transfer business assets to the company.

Can I change from limited company to sole trader?

Technically yes, but it involves winding up the company and could have tax implications. It’s best done with professional advice.

How can Gerald Edelman help?

Whether you’re just starting out or looking to optimise an existing structure, Gerald Edelman’s Business Advisory experts can help you weigh up your options, assess your tax position, and support you through the incorporation process.

Get in touch today to discuss whether forming a limited company is the right move for your business. Alternatively, to see how we can help you and your business, visit our business advisory page to learn more.