Freelance: Setting up your business

So you’ve decided to work for yourself. You will need to choose how to set up your business legally. The two main options are: you can choose to register as a sole trader. This is considered the simplest option where you and your business are legally the same.

Alternatively, you might decide to make your business a limited company. As a limited company, your business is a separate legal entity, meaning the company exists in its own right, not as “you”. Which option is best depends on things like the size of your business, how much risk you want to take on, how you want to pay tax and how much control you want. It is possible, but can be tricky to change later, so it’s worth thinking carefully and, if possible, asking a professional like an accountant or business advisor for guidance. 

Here are some questions to help you decide:

One. Is it just you in the business? As a sole trader, you are the owner and the business. A sole trader makes every decision. There’s no legal difference between your personal money and your business money. While there’s no legal difference between personal and business money, it’s still good practice to keep them separate in different accounts for easier bookkeeping and tax. If registered as a limited company, the business is its own legal entity. The company’s money and responsibilities are separate from yours. It can have one or more owners, they can also be referred to as shareholders. Shareholders own the company by holding its shares. The owner might be the director but directors can also be appointed by the shareholders to manage a company’s day to day operations and make strategic decisions. While shareholders have ownership rights and the power to appoint or remove directors, they don’t automatically have day to day managerial power. 

Two. How much risk are you willing to take? Being a business owner whether a sole trader or limited company carries responsibility. You may have heard the term ‘liable’. Liability means being legally or financially responsible if something goes wrong. Sole traders have unlimited liability – if the business owes money or gets sued, you must pay personally, even using your savings or home if necessary. For limited companies, owners have limited liability. You only risk the money you put into the company and your personal assets are usually protected.

Three. How much profit do you expect? If you expect to earn a small or modest amount, operating as a sole trader may be simpler. But if you expect higher profits, a limited company may help reduce your overall tax bill, but it comes with more admin.

Four. Do you want a simple tax setup? How much tax you pay depends on whether you’re a sole trader or run a limited company. When it comes to tax, being a sole trader is slightly easier to manage. As a sole trader, your profit is treated as your personal income. The income from freelancing or other forms of self-employment and from a business you own must be reported to HMRC and you will likely need to pay tax on it, depending on how much you make. Your profits are the money that your business makes after deducting all allowable business expenses from your total business income. When you complete your personal tax return, you pay income tax and national insurance on what you earn, after your tax-free allowance is taken off.

A personal tax return is how you report income that isn’t taxed automatically, like through PAYE, pay as you earn. Limited companies have more rules and reporting than sole traders including filing annual accounts with HMRC. If you run a limited company, things work a bit differently. The company pays corporation tax on its profits when they are over a certain amount, but you can then choose to pay yourself in a tax-efficient way, often by taking a mix of salary and dividends. You may still have to pay personal tax on this, but being a limited company can sometimes reduce the total tax bill compared to being a sole trader. It’s worth making sure you have an accountant who can support you with understanding what’s best for your circumstance.

Five. How private do you want your finances to be? For sole traders, your tax details are private and only shared with the tax authorities. As a limited company some information like your annual accounts and company details, must be filed publicly on the government site, Companies House.

Six. How will you fund your business? How will you fund your business? Funding usually comes from your own money as a sole trader, this might include using personal loans or small business loans. Investors, individuals that believe in the potential of your business, are sometimes interested in owning part of your business in return for money that they contribute to its growth. It’s harder to attract investors because as a sole trader you can’t sell shares. If you run a limited company, you may attract investors. You can raise money by selling shares even before you start generating profits. Investors and lenders, such as banks, may also feel safer lending to a limited company than a sole trader because of the limited liability protection. If the company becomes insolvent, creditors can only claim the company’s assets, not the personal assets of the owners.

Seven. Will you be the only worker for the long term? A sole trader business is very tied to you. If you stop working or pass away, the business usually ends. A limited company exists on its own, so it can continue even if you step back or sell it. The right choice depends on your goals. Registering as a sole trader is simpler and quicker to set up, while a limited company offers more protection and funding options, but comes with extra admin.

Whichever legal structure you choose, having a business means managing money, and you’ll need to start planning how you budget for your business.

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