If you’re running a small business in the UK, you’ve likely asked yourself this question at least once: “Should I form a limited company?”
The decision to move from sole trader to limited company status can feel like a big step, but it’s one that could bring substantial benefits, especially when it comes to tax, liability, and credibility.
But is forming a limited company the right move for you?
In this blog post, we’ll break down what forming a limited company means, the benefits and drawbacks, and how to know if it’s the right time for your business to take the plunge.
- What Does Forming a Limited Company Mean?
Forming a limited company essentially means that your business becomes a separate legal entity from you as an individual. As a sole trader, you and your business are the same. However, when you form a limited company, the company exists independently, and your personal assets are separated from the business.
This distinction is important to note.
As a sole trader, you are personally liable for any debts or legal issues your business faces. When you form a limited company, your personal liability is limited to the value of your shares in the business. In other words, if your business runs into trouble, your personal assets (like your home or savings) are protected, up to a point.
Key Features of a Limited Company:
- Separate legal identity from the business owner.
- Limited liability for directors and shareholders.
- The company must be registered with Companies House.
- Owners take a combination of salary and dividends, rather than just income.
- Benefits of Forming a Limited Company
So, why do so many businesses opt for the limited company structure? There are several key advantages, especially when it comes to financial and legal protections.
Limited Liability
Perhaps the biggest advantage of forming a limited company is limited liability. As mentioned earlier, your personal assets are protected if things go south. This is especially important if your business involves significant risk or financial exposure.
Tax Efficiency
Another big draw is tax efficiency. While sole traders pay income tax on all their profits, limited companies pay corporation tax on their profits, which is currently set at 19% (or 25% for profits over 50k). Owners can also choose to take a salary from the business and supplement it with dividends, which are taxed at a lower rate than regular income.
By carefully balancing your salary and dividends, forming a limited company could save you a fair amount of tax in the long run. This is especially true once your profits exceed the personal allowance threshold.
Professional Image and Credibility
Having “Ltd.” after your business name can make you appear more established and trustworthy. It adds a level of professionalism that can help you attract bigger clients, secure more contracts, and even access funding opportunities that might not be available to sole traders.
Opportunities for Growth
As a limited company, you have the flexibility to bring on shareholders, which could be key if you’re planning to expand. This structure allows for growth by bringing in additional investment and issuing shares.
- Drawbacks of Forming a Limited Company
Of course, forming a limited company isn’t all sunshine and rainbows. There are also some downsides to consider, and it’s important to weigh these against the potential benefits.
Administrative Burden
Running a limited company comes with more paperwork and legal responsibilities than operating as a sole trader. You’ll need to file annual accounts with Companies House and HMRC, submit a confirmation statement, and work with an accountant to ensure everything is done correctly. The administrative burden can be time-consuming, and if compliance isn’t met, you could face fines.
Additional Costs
Forming and maintaining a limited company can come with some added expenses. While it’s relatively affordable to set up a limited company (£50 to register online with Companies House), you may encounter ongoing costs, such as accounting fees. However, if your goal is to grow and make money, investing in an accountant is well worth it. A good accountant will help you manage your taxes efficiently, plan your finances, and keep you compliant with HMRC, helping you avoid any trouble with the taxman.
Loss of Privacy
As a limited company, your financial information becomes public. You’ll need to file annual accounts and a confirmation statement with Companies House, both of which are publicly accessible. This means anyone can view details about your company, including its earnings, directors, and registered office address. It’s important to note though, that most accountants will allow you to use their address so that your personal information stays private.
More Rigidity
Operating as a limited company is more structured than being a sole trader. You’ll need to follow strict rules and procedures, such as holding board meetings and keeping accurate records of company decisions. If you prefer flexibility and simplicity, this could feel like an unnecessary burden.
- How to Know If It’s Time to Form a Limited Company
The big question: when should you form a limited company? While there’s no one-size-fits-all answer, there are some clear indicators that suggest it might be the right time.
Your Profits Are Growing
If your business is becoming more profitable, forming a limited company could help you save on taxes. Once your profits reach a certain level (usually around £30,000 or more), the tax advantages of a limited company become hard to ignore. By balancing salary and dividends, you can reduce your overall tax burden.
You Want to Minimise Risk
If your business involves a certain level of risk—whether financial, legal, or operational—limited liability can provide a layer of protection for your personal assets. If you’re signing large contracts, taking on significant debt, or entering an industry with potential legal complications, forming a limited company could help safeguard your finances.
You’re Ready to Grow
If you’re looking to scale your business and bring in additional investment, a limited company structure will give you the flexibility to issue shares and take on new partners. Whether you’re seeking venture capital, business loans, or bringing on additional directors, having a limited company can make it easier to manage growth.
You Want to Enhance Your Professional Image
Sometimes, having “Ltd.” after your company name can open doors. Many larger clients or government contracts prefer to work with limited companies because they’re seen as more stable and credible. If your goal is to attract bigger clients or elevate your brand, forming a limited company can help boost your professional image.
- What Is the Process of Forming a Limited Company?
If you’ve decided that forming a limited company is the right move for you, the process is relatively straightforward.
Step 1: Choose a Name
The first step is selecting a name for your company. It must be unique and not too similar to an existing company’s name. You can check if your preferred name is available on the Companies House website.
Step 2: Register with Companies House
Once you’ve got your name, you’ll need to officially register your business with Companies House. We recommend using an accountant to complete this step, to ensure the application is completed correctly.
Step 3: Set Up Your Business Bank Account
Because a limited company is a separate legal entity, you’ll need a business bank account to keep your personal and business finances separate.
Step 4: Keep Records and File Accounts
Once your limited company is up and running, you’ll need to stay on top of your administrative responsibilities. This includes keeping track of all finances, filing your annual accounts, submitting a confirmation statement to Companies House, and paying corporation tax.
Deciding whether forming a limited company is right for your business can feel overwhelming, but you don’t have to make the decision alone.
At Keirstone, we specialise in helping small business owners weigh the pros and cons of different business structures. Our expert advice can help you navigate the process and make sure that forming a limited company is the right move for your business.
Schedule a call with us today to discuss your business goals, tax-saving strategies, and how to set your company up for success!
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