The Pros and Cons of Operating as a Limited Company vs Sole Trader
Deciding on whether to set up your business as a limited company or sole trader is a key decision for any entrepreneur. There are advantages and disadvantages to both structures in terms of control, liability, taxes and administration. Understanding these key differences will enable you to pick the right model.
Defining the Models
A limited company is a separate legal entity from its owners. It provides limited liability, so the owners’ personal assets are protected. Sole traders operate as individuals, so don’t have this protection. Limited companies also face more regulation and reporting requirements.
1. Control and Flexibility
Sole traders have complete control as there are no other shareholders or directors to consult. This enables fast, flexible decisions. Limited companies have more complex processes with company filings and shareholder votes. However, shareholders can contribute different skills.
2. Liability Risk
Limited companies limit the owners’ liability. Sole traders face unlimited liability, so their personal assets are at risk if sued. Many contractors and consultants opt for limited companies to protect their assets. Creditors prefer lending to limited companies.
3. Taxes
Limited companies have more tax planning options and the corporate tax rate is lower. However, profits may be taxed when paid out as salary and dividends. Sole traders simply pay income tax on profits. Expenses are also easier to claim as a sole trader.
4. Administration
Limited companies have more reporting requirements, like filing annual returns and accounts. There’s also more paperwork when paying salaries and dividends. Sole traders simply report business income on their personal tax return.
5. Funding and Growth
Limited companies can sell shares and receive investment. This facilitates growth and expansion. Banks also favor lending to limited companies. Sole traders can only use debt financing and bootstrapping. But some prefer less bureaucracy.
There are pros and cons to both business structures. Assessing your specific situation will enable you to make an informed decision. Take the time to understand the implications before committing.
The Decline of Sole Proprietorships
Over the past decade, there has been a clear downward trend in the number of sole proprietorships globally. According to research from the OECD, between 2010 and 2020 the number of non-corporate enterprises, which are overwhelmingly sole proprietorships, declined by 12% among OECD countries. This downward trend is likely driven by several factors, including rising compliance costs and administrative burdens that make the sole proprietorship structure less appealing. The OECD predicts this decline will continue in the coming years as larger firms gain market share.
The Rise of Limited Companies
In contrast to sole proprietorships, the number of limited companies has steadily increased over the last 10 years. Data from the World Bank shows that the number of new limited liability companies registered in developing countries increased by over 25% between 2011 and 2021. This growth was particularly pronounced in countries like India and Brazil. The key reasons for this rise include the limited liability protection and perceived credibility afforded by the limited company business structure. With easier online registration processes, limited companies have also become more accessible globally.
Developing Economies Drive Growth
When it comes to new business formations, developing economies are predicted to be the main source of growth for limited companies in the future. Consulting firm McKinsey & Company estimates that emerging markets will account for up to 70 percent of new business creations in the next decade, with Africa and Southeast Asia leading the way. With expanding middle classes and increased entrepreneurial activity in these regions, limited companies are expected to continue their ascent as the preferred type of entity, outpacing sole proprietorships.
References:
https://www.ssm.com.my/sites/default/files/guidelines/OWNER%20RESPONSIBILITY_new.pdf
http://gst.customs.gov.my/en/SiteAssets/doc/Registering%20for%20GST%20Amend%201.pdf
https://www.sba.gov/sites/default/files/SDOLoanFactSheet_Oct_2011.pdf
https://www.oecd.org/industry/business-stats/corporategovernance.htm
https://data.worldbank.org/indicator/IC.BUS.NREG
https://www.mckinsey.com/featured-insights/employment-and-growth/whats-driving-africas-growth
https://www.gov.uk/limited-company-formation/comparing-limited-companies-and-sole-traders https://www.companyformacompany.co.uk/blog/limited-company-vs-sole-trader https://www.ipse.co.uk/resource/comparison-contractor-limited-company-umbrella.html
