Why you should consider registering a startup business as a limited company

When you set up a new business deciding on what business structure you use will be one of the most important decisions you make.

New startup businesses can trade as sole traders, Limited Liability Partnerships (LLP) or limited companies. There are benefits to registering a startup business as a limited company, including protecting personal assets, tax savings, professional image and future investment.

In this blog we’ll look at the advantages of operating as a limited company vs operating your new business as a sole trader.

What is a limited company?

A limited company is a type of business structure in the UK that is a separate legal entity from its owners, offering limited liability protection.

Because they operate with their own separate legal identity, this legal distinction means the company is separate from its shareholders and directors, providing benefits and protection of personal assets should the company fail or have legal action filed against the company.

If an individual opts to run the business as a limited company, the business will:

• be legally distinct from the person(s) responsible for running the business;
• maintain separate finances for both business and personal finances.

Limited companies are incorporated with Companies House in the UK.

What is a sole trader?

A sole trader business is controlled and owned by one individual who is self-employed. Legally there is no separation or distinction between you as the individual and the business. This is significant because if your company gets into financial trouble you will be personally responsible for them. This means your personal assets such as your home and savings etc. are at risk.

Anyone can start a sole trader business without having to register at Companies House. You do, however, have to register with HMRC as being self-employed and submit a self assessment tax return each tax year.

Benefits of registering as a limited company

Tax benefits

A limited company offers tax advantages over and above sole traders. A limited company is generally more tax-efficient from a personal tax point of view than operating as a sole trader as you’ll be able to pay yourself as a director of a limited company via salary and dividend payments.

As a limited company director, you will typically take a small salary (with little or no personal tax liability) and the remainder of your income in the form of dividend payments (which you pay dividend tax on but are free from National Insurance Contributions). Dividend tax rates are asignificantly lower than standard personal tax rates.

However, your company will be required to pay corporation tax on your company’s profits. Corporation tax for companies is typically at a lower rate than income tax rates paid by some sole traders. Corporation Tax increased from 1 April 2023. For small companies with profits of less than £50,000, the rate is 19%. For businesses whose taxable profits exceed £250,000, the rate is 25%. For companies in between there will be a sliding scale of rates.

Limited company directors are required to complete a self assessment tax return each year to declare their income from all sources including dividends etc.

There are also other potential tax saving advantages as limited companies can claim more things as a tax deductible expense than sole traders can. Read more in our dns expense guide for limited companies.

When you’re self-employed as a sole trader, you have to complete a Self Assessment tax return to let HMRC know about your income based on the profit you make from your business activities and any other income you earn. HMRC will then calculate the Income Tax and National Insurance you will need to pay.

Sole traders will have to pay income tax on all of the business profits they make and will also pay National Insurance Contributions. Self-employed sole traders pay National Insurance based on how much profit they make from their business.

Sole traders also can claim less in the way of business expenses against their profits.

Limited liability

One huge benefit of forming and registering your startup as a limited company is your company has its own legal identity and therefore provides limited liability protection to you as an individual.

This means, that should your company run into financial problems, your personal assets will be secure. This is because a limited company is treated as a separate legal entity in its own right and therefore you don’t have personal liability for company debts etc. If your company becomes insolvent and is unable to pay its creditors, you will only be required to contribute the nominal value of your unpaid shares. Beyond that, your own assets will be protected.

Shareholders of a company have a capped liability for debts, losses, liability claims or legal claims. Their liability is limited to the amount paid for their shares plus any unpaid amount on nil or partly paid shares.

A sole trader, runs a much higher personal financial risk as they have potentially unlimited personal liability as the legal status of the business and the individual is not separated. This means the individual is personally liable for business debts, losses, legal claims and liabilities, creating greater risk for their own finances and personal assets.

This is why forming a limited company is far better to limit liability for individuals and separate out your company financial obligations from your personal finances.

Protecting a trading name for a future business

As a startup business owner, you’ll think long and hard about what name to give your new company. Limited companies are required to have unique names, therefore incorporated businesses are protected from others using their trading name if they have incorporated and registered their business name at Companies House.

Once your name is registered, it becomes protected by UK law and no-one else can use your business name to trade under it.

Sole trader businesses do not get this protection of their company trading name.

Improved credibility and professionalism

Establishing a limited company can improve the credibility and professionalism of your business. Having a distinct legal entity with a distinct name and brand can help build trust with customers, suppliers, and other stakeholders. This can be particularly important for businesses looking to secure larger contracts, attract investment, or operate in more competitive markets.

Forming a private limited company suggests permanence and commitment to effective and responsible management. It gives suppliers and customers a sense of confidence. Many companies, particularly larger organisations, will not deal with a business that’s not a limited company.

Ability to raise capital and secure investment

Setting up a limited company allows the business to raise capital more easily by issuing shares. This can be particularly beneficial for companies looking to expand, invest in new projects, or fund their growth.

Investors are also often more willing to provide funding to a limited company. Companies can also potentially secure funding from tax-advantaged schemes like Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS).

This means that you don’t necessarily have to use your own assets or finances to secure business finance.

Disadvantages of a limited company

There are some disadvantages of becoming a limited company structure over being a sole trader, but in most cases the advantages of running a limited company far outweigh the disadvantages and in comparison to sole traders.

Some of the disadvantages are as follows:

• Limited companies must be incorporated at Companies House.
• Your choice of business name may be restricted if others have claimed the name already.
• There are setup costs associated with setting up a limited company, including registration fees for company formation.
• You will be required to pay corporation tax on profits and submit corporation tax returns.
• There are more reporting requirements for a limited company. For example, you will be required to submit a Confirmation Statement and annual accounts to Companies House each year.
• You cannot register a company if you are an undischarged bankrupt or a disqualified director.
• Personal and corporate information will be disclosed on public record at Companies House.
• Strict rules apply when withdrawing money from the business.
• Limited companies need to adhere to strict record-keeping requirements, including minutes of meetings and recording all decisions taken by directors and shareholders,
• Any changes to your company details, must be notified to Companies House immediately.
• You are likely to need an accountant such as dns accountants to help with business finances and to prepare annual accounts for submission at Companies House.

How to set up a limited company

There are several key steps involved in setting up a limited company in the UK. Let’s go through each one in detail:

Choose the type of limited company

Firstly, you’ll need to make is the type of company structure that best suits your business. The main options are:

• Private company limited by shares: This is the most common type of limited company, where the owners’ liability is limited to the amount they have invested in the company’s shares.
• Private company limited by guarantee: This structure is often used for non-profit organisations, where the members’ liability is limited to a pre-agreed guarantee amount.
• Limited liability partnership (LLP): An LLP combines the flexibility of a partnership with the limited liability protection of a company.

Carefully consider the benefits of each structure to determine which one aligns best with your business goals and needs.

Choose a company name

Selecting the right company name is an important step. The name must be unique and cannot be the same as an existing company or trademark. It must also end with the word "Limited" or the abbreviation "Ltd."

When choosing a name, make sure it is memorable, reflects your business activities, and is available for registration. You can check the availability of a proposed name on the Companies House website.

Appoint directors and a company secretary

Every limited company must have at least one director. This person is responsible for the overall management and decision-making of the company. You can also choose to appoint a company secretary, although this is not a legal requirement.

The directors and company secretary will be registered with Companies House and their details will be publicly available. Consider carefully who you want to take on these roles and ensure they understand their legal duties and responsibilities.

Prepare the memorandum and articles of association

These are the two key documents that outline the company’s rules and the responsibilities of the directors. The memorandum of association sets out the company’s name, registered office, and the business activities it will undertake. The articles of association cover the internal management and administration of the company.

You can either draft these documents yourself or use a template provided by Companies House or a professional service.

Register the company

The final step is to register the company with the UK’s registrar of companies, Companies House. This involves submitting the necessary forms and documents, either online or by post. The process typically takes 8-10 working days to complete.

Once registered, your company will be issued a unique company number and will be officially recognised as a legal entity.

Obtain a registered office Address

Every company registered at Companies House must have an official registered office address, which is the address where the company’s legal documents will be sent. This address will be publicly available on the Companies House register.

You can use your home address or rent a registered office address from a service provider.

Summary

Whilst setting up as a sole trader can be quick and simple, registering with Companies House is not hugely more complex.

However, when starting out in business, you should carefully consider the pros and cons of each option based on your business goals and ambitions.

Speak to an accountant such as dns accountants to evaluate your personal circumstances, tax efficiency, liability, and credibility implications of each type of business structure before you begin to trade.

A limited company doesn’t have a requirement for personal guarantees from company directors but do carry additional responsibilities for the directors/shareholders. But your personal income, identity and credibility will be better protected by a limited company.

The legal distinction and tax efficiency of limited companies are what make limited company formation attractive to many business owners.

Seek professional help and guidance from dns accountants

Consult with an accountant or business advisor like dns accountants to decide the best legal structure for your business based on your business objectives and personal circumstances.

We can help you navigate the company registration process, assist with company formation, ensure compliance with tax obligations, advise on relevant tax relief and assist with all Companies House filing requirements. Contact dns on 03300 886 686 or email us on enquiry@dnsaccountants.co.uk.

About the author

Siddharth Agarwal
I am a Chartered Tax Advisor (OMB) and ACCA. I have 9+ years of experience in owner-managed business taxation issues, company reorganisations, property taxation, and succession planning. I also work with private clients on bespoke tax planning strategies for trusts, residence status, and non-residents. I aim to fulfil my professional duties towards my clients and keep them satisfied, my utmost priority. I believe in establishing and maintaining businesses and personal relationships as the key to mutual growth.