When is the right time to form a limited company?

Darren Fell, managing director of Crunch Accounting, discusses when becoming a limited company might be the correct next step up from being a sole trader as a small business.

Many new businesses begin with a bit of freelance work to supplement salaried income, which grows until eventually the freelance work takes over. The full-time job is discarded, and the freelance work takes over. A new enterprise is born!

Most entrepreneurs who go into business this way work as sole traders for the sake of simplicity. Tax is paid in a similar way to salaried employment and you don’t have to deal with HMRC or Companies House too much. After a while many freelancers decide to form a limited company for their business though, either out of personal preference or on the advice of their accountant.

There is no demarcation line at which a limited company becomes a necessity, and it usually comes down to personal preference. So, what should you consider when thinking about incorporating?

Limited liability

The biggest difference from a legal perspective is that, operating as a limited company, you and your business are distinct legal entities. Profit and expenses come in and out of your business’s bank account, not yours. This extra layer of separation means that if things should go pear-shaped and you go bust, you only stand to lose what you invested in the business. Your creditors cannot touch your personal belongings.

Tax efficiency

As an employee or sole trader your options in terms of how you handle your income are fairly limited; money arrives in your account, you pay tax on it. As the director of a limited company you have a few more options. Your income will actually be revenue for your company, which you can withdraw as a salary, a dividend (which attracts a lower tax rate), or even leave in the company altogether.

As a limited company you will also only pay corporation tax on your profits, rather than income tax and national insurance on your entire income.

Extra employability

By packaging up your services within the tidy wrapper of a limited company you make yourself more hirable to prospective clients. Indeed some companies, especially in the financial services sector, require freelancers and contractors they use to have their own limited company.

Room to grow

With a limited company your options for growing, changing or otherwise rejigging your business are greatly increased. Taking on employees is as simple as adding them to your PAYE scheme, and you can even take on investment should you wish, by selling shares. As the sole director and shareholder you begin with complete control of your company, but should you wish to team up with a fellow entrepreneur you can issue half the shares to them.

If you suddenly become wildly successful and want to cash out, you can even sell your entire company!

Not all good news

There are, of course, drawbacks to incorporating. As the director of a limited company you will be beholden to a set of rules called the Director’s Fiduciary Responsibilities, and be required to file returns with HMRC and Companies House every year.

As part of this process certain information about your company will be held on the public record at Companies House, and can be viewed by anyone who requests it.

However, the biggest mental hurdle for most people – actually forming the company – has been dramatically simplified thanks to online formation agents. A company can now be formed for not much more than £10 in just a few minutes.

Further reading on Limited Companies

Watch the below video on what is a limited company

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Darren Fell

Darren Fell is founder and managing director of Crunch Accounting.

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