One of the first questions people ask when they are setting up a business is whether they need to set up a company. It’s a good question.
For most people the choice is between trading as an individual (becoming a sole trader) and setting up a company.
Limited liability to keep you safe
When people talk about companies they normally mean ‘limited liability’ companies. This concept of ‘limited liability’ is crucial to answering the original question.
The biggest single reason to trade through a company rather than as an individual is that your liability will be limited.
Put simply, if you trade as an individual and things go pear shaped you can lose all of your possessions and go personally bankrupt. Alternatively, if you trade as a company the worst that can happen (as long as don’t do anything illegal) is that the company runs out of money and is wound up.
In a limited liability company, the liability of the owners is limited to the value of the companies shares, which is often as little as a pound or two.
Building a team with your company
The other non-tax-related reason for trading through a company is that it can allow you to build a team (crucial to the success of many businesses). The law sees companies as ‘people’ that can enter into agreements and generally be an actor in the world of business; but behind that company can be a complex ownership structure.
There are other ways to build a business with other people. Industries dominated by services that are strongly linked to individuals, like law and accountancy, have made great use of partnerships (they have also historically been restricted from setting up companies). Parnerships are a legal mechanism for people to do business together without setting up a company.
Paying less tax
If you don’t think tax is important, you are wrong.
Small businesses generally have to work very hard to get started; you don’t want to be giving away any more money than you absolutely have to.
The key differences are that an individual’s profits are taxed under the income tax regime, which includes national insurance liabilities, but company profits are taxed under the corporation tax regime.
You will usually pay less tax as a company.
Of course, if you set up a company and make a profit you still have the challenge of how to get this into the pockets of the individuals who own that company. Rest assured there are ways to do this that maintain the tax benefits of trading as a company: often dividends combined with small salary payments.
Regulation: frustrating but manageable
The main disadvantage of trading through a company is that you (a) have to go through the hassle of setting up a company and (b) have to go through the hassle of complying with yearly reporting requirements to Companies House, the body that governs companies in the UK.
In the grand scheme of challenges you will face, neither of these are likely to be substantial.
The answer: probably yes
If you are setting up a small business that is likely to always focus around selling your personal skills, and if you hate admin, then it may be best to go the sole trader route. However, if you are serious about the growing a business then it is best to bite the bullet and ‘get incorporated’.