Deciding between Sole Trader vs Limited Company vs Umbrella

Chris Andreou

April 21, 2021

sole trader vs limited company guide

Free Download: Registering a Limited Company Guide

Download Now ↓
Limited Company

Introduction

If you're planning to start out on your own, one of the most important decisions you'll need to make is figuring out how you should structure your business. 

As a freelancer, contractor or small business owner, there are three main types of legal structures you should consider: 

  • Sole proprietorship 
  • Limited company
  • Working through an umbrella company

It's a decision that requires careful consideration, and it's important that you seek advice from qualified professionals when you weigh out the pros and cons of each business structure. To begin with, you need to have a good grasp of the basics - and here's where our guide comes into the picture. 

Business structures: Understanding the basics

1. Sole trader

As a sole trader, you run and control your company as an individual, and are considered a self-employed person. You are personally responsible for the decisions, as well as profits or losses of the business. 

Sole traders can hold a variety of professions—from electricians and plumbers, to graphic designers and software developers.  

2. Limited company

A limited company is a type of business structure where the company has its own legal identity. The assets and liabilities of the company are separate from the personal finances of its owner.

As a director and shareholder, you cannot withdraw money out of your business as and when you want to, and profits that are made belong to the company. Even if an individual is the only shareholder and director, the company is still a separate legal entity. 

3. Umbrella company

An umbrella company acts as an intermediary between a contractor or freelancer and their agency or client. This means that the agency or end client engages with the umbrella company, rather than directly with the contractor or freelancer.  

If you decide to work through an umbrella company, you will be considered an employee. You will not be in charge of managing your payroll, and will instead submit a timesheet and expenses information to the umbrella company on a monthly basis. 

The company will also handle your tax, pension and National Insurance contributions, and you will be entitled to statutory employment benefits, such as holiday pay and sick pay.

Planning on setting up a company

Registering a Limited Company Guide

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
Registering a Limited Company Guide

Weighing out the pros and cons: Sole Trader v Limited Company v Umbrella

Why become a sole trader?

  • Simplicity. Setting up as a sole trader is a fairly easy process. Plus, you'll deal with minimal paperwork apart from filing your annual Self Assessment tax return, and abiding by HMRC's record keeping requirements. 
  • The accounting process is also simpler, as there are typically fewer clients and expenses to account for compared to operating a limited company.
  • Privacy advantage over other types of businesses. Sole traders can operate with more privacy, as you're not required to share certain information - such as your company accounts and confirmation statement - with Companies House. This isn't the case for incorporated businesses, which are required to share certain information with the public. 

Why not?

  • Unlimited liability. Unlike a limited company, a sole trader business isn't a separate legal entity; the law doesn't distinguish between the individual running the business and the business itself. 
  • You will be personally liable for the debts that your business incurs, and your personal assets can be seized to pay off these debts. 
  • It can be tax inefficient. You may benefit from greater tax savings if you run your business as a limited company - particularly if your profits go above a certain threshold. That's because limited companies pay 19% Corporation Tax on their profits, compared to the 20-45% Income Tax that sole traders pay on their profits. 
  • Obtaining external financing can be a challenge. Banks and investors tend to prefer lending to limited companies, so obtaining external financing can be tricky when you're looking to expand your business. 

Why set up as a limited company?

  • Limited liability. Your company is a separate legal entity. As such, your personal finances and assets are protected, and can't be seized to pay off debts in the event that your company encounters financial difficulties. 
  • Tax efficiencies. In general, you'll benefit from greater tax savings if you run your business as a limited company - particularly if your profits go above a certain threshold. 
  • This is because limited companies pay 19% Corporation Tax on their profits, compared to the 20-45% Income Tax that sole traders pay on their profits. 
  • You will also be able to claim a wider range of allowances and business expenses compared to a sole trader. 
  • Increased credibility and commercial acceptance: A limited company tends to appear more credible to businesses, investors, customers and financial institutions, which can lead to increased business opportunities and easier access to finance.

Why not? 

  • Increased legal and administrative requirements. Operating as a limited company presents increased legal compliance and administrative requirements.
  • You need to fulfil your fiduciary duties as a limited company director, and are responsible for ensuring that your company submits the required documents at the financial year-end to Companies House and HMRC. 
  • The record keeping and administrative requirements can be extensive and time consuming, thereby increasing the general and administrative costs of your business.  
  • Details of company are publicly available: Limited companies are required to disclose certain information, such as information about its directors and company earnings on the public records.

Why work through an umbrella company?

  • Ease of use. Working through an umbrella company relieves you of the administrative burden that self-employed individuals typically deal with, such as managing your business finances, company accounts and bookkeeping. 
  • You will receive a salary (along with a pay slip that shows how it's calculated). No further deduction needs to be made as your income tax deductions and National Insurance contributions are accounted for. 
  • Flexible. The ease of use that an umbrella company offers makes it a great option for individuals who aren't yet sure if they want to commit to freelancing or contracting for the long term, and want to test the waters by doing short-term contract work. 

Why not? 

  • Costly way to operate: Working through an umbrella company is generally the most expensive way to operate. You're required to pay PAYE, tax and National Insurance contributions—just like a full-time employee. 
  • Plus, your umbrella company will impose a fee for using its services. Additionally, you will not be able to take advantage of the tax efficiencies that a limited company structure offers.
  • Lack of control: You're not able to enjoy the same level of freedom as you would have operating as a sole trader or through a limited company. You'll have less control over a variety of aspects—from taxation, to when and how much you're paid. 

3 Key factors you need to evaluate

When deciding between the different business structures, there are various commercial and tax-related factors you need to consider.

Below, we've elaborated on the three key factors you need to evaluate:

1. Legal liability

"To what extent do I need to be protected from legal liability?" is an important question that all business owners need to evaluate.

In an Entrepreneur article, Mark Kalish, co-owner of EnviroTech Coating Systems Inc. further elaborates: "You need to consider whether your business lends itself to  potential liability  and, if so, if you can personally afford the risk of that liability."

He shares an example: in setting up EnviroTech, Kalish and his co-founder had made a sizable investment in equipment, and had important contracts to fulfil. As such, they decided to incorporate, as they didn't want to take on personal liability in the event that their company incurred losses. 

2. Future needs and long-term objectives

The initial stages of setting up your business can feel scary, exciting and all consuming - and leave little time for you to reflect on longer term goals, or to question yourself about what your business might be like in five or ten years. 

For instance, what will happen to your company if you're no longer around to run it? A sole proprietorship will be legally dissolved upon the death of its owner, while a limited company will continue its operation as the shares can be distributed to family members or to the remaining shareholders.

Other important questions you need to consider include: What are your funding needs and options for obtaining financing a few years down the road? Do you plan to sell your partnership share, buyout a partner or bring in additional stockholders as you expand? 

3. Ongoing administration

In discussing the pros and cons of operating as a limited company above, we've highlighted one of the downsides it presents—which is increased legal and administrative requirements.  

Managing these aspects can be challenging, particularly for time-pressed business owners juggling between multiple roles. Before you incorporate your business, it's important that you ensure you have the time, ability and manpower resources to meet the stringent record keeping and reporting requirements imposed by HMRC and Companies House. 

Kalish shares a word of advice: "I would always take sole proprietorship as a first option. If you're a sole proprietor and you own 100 percent of the business, and you're not in a business where a good umbrella insurance policy couldn't take care of potential liability problems, I would recommend a sole proprietorship.

"There's no real reason to encumber yourself with all the reporting requirements of a corporation unless you're benefiting from tax implications or protection from liability."

Registering a Limited Company Guide

What's Inside:

  • What is a Limited Company
  • 10 step process for setting up a Limited Company
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.
Registering a Limited Company Guide

What's Inside:

  • What is a Limited Company
  • 10 step process for setting up a Limited Company

Get Free Advice from an Accountant

Book a free 30 minute call with an accountant. We'll help walk through setting up your business, switching accountant or any of your tax queries. All our accounting packages come with a free 30 day trial.

type of business guide
Featured Article

What type of business structure is best for you?

Guide to the benefits and drawbacks of five common business structures

Read more

Read More Guides below:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Contractor Business Services UK

Firstly, we'll start with the services that we provide which covers the critical things you'll need to start and operate your contracting business.

For those just getting started, we provide free company registration on Companies House. This is typically done within 24 hours of submitting your details to Forma. It can take under 5 minutes to provide all your details and we'll just need a proof of ID and proof of address for each of the company directors.

We cover all of your key company filing requirements like annual accounts, confirmation statements, corporation tax and ensuring you meet all filing deadlines.

We also help with your annual Self Assessment which is a requirement for all company directors.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

19 Places to Find Contractor Jobs & Roles

When you get into contracting, it can get stressful when your project end date is just around the corner and you haven't secured your next role. This amps up even more once you finish a contract and you're looking for your next gig.

As a specialist contractor accounting business founded by contractors, one of the key questions we get asked is about where to find roles. So, we decided to compile a list of some of the best contractor job portals, platforms, recruiters and consultancies.

If you have anything else to add then please let us know at info@goforma.com.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Umbrella Companies Explained: FAQs for Contractors

Whether you're newly self-employed or an experienced contractor, there'll be aspects that you need more information on when you're deciding if working through an umbrella company is right for you.

To help you along, we've compiled a list of FAQs that contractors often ask:


Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

What is a sole trader?

If you're planning to start out on your own, one of the most important decisions you'll need to make is figuring out how you should structure your business.

As a freelancer, contractor or small business owner, there are three main types of legal structures you should consider:

  • Sole proprietorship
  • Limited company
  • Working through an umbrella company

It's a decision that requires careful consideration, and it's important that you seek advice from qualified professionals when you weigh out the pros and cons of each business structure. To begin with, you need to have a good grasp of the basics-and here's where our guide comes into the picture.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Key considerations when you register a Limited Company

As a freelancer, contractor, or small business, it is typical to start with the simple structure of operating as a Sole Trader.

While taxes and other administrative work may be relatively easy when you are a Sole Trader, as your volume of business goes up, there are more and more reasons to take on the task of becoming a Limited Company.

For instance:

  • A Limited Company protects your personal assets. If you are found liable in a lawsuit, only your business assets are at risk.
  • A Limited Company is usually more tax efficient than being a Sole Trader.
  • Once you have your name chosen as a Limited Company registered through Companies House, no one else can take your company name.

Luckily, running a Limited Company doesn't have to be exceedingly complex, though following a set plan will help to keep the complexity to a minimum.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Is a contractor an employee?

Contractors can be self-employed, a worker or an employee. Those who are employed through an umbrella company or an agency could be considered a worker or an employee.

If a contractor is a sole trader or runs a limited company, he or she will then be considered a self-employed person.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

What are the advantages of contracting?

The advantages of contracting are:

  • Flexibility: Contractors have a lot more control over their work life often deciding when they work, where they work and how they work
  • Increased earnings: Contractors are often paid more due to their skillset and the flexible nature of their working relationships. Additionally, contractors who operate through their own limited company can benefit from tax efficiencies.
  • Greater development: Often working with multiple clients throughout their career, contractors are exposed to a lot of opportunities to develop their skills and build on their experience in their area of expertise.
Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

What is subcontracting?

As an independent contractor, there may come a point in time where you need to consider subcontracting-you might decide to take on work as a subcontractor, or hire a subcontractor for your projects.

Whichever option you're exploring, how do you decide if the benefits truly outweigh the cons? And are there important tips you need to keep in mind?

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

How to Become a Contractor

So, you're thinking of becoming a contractor.

There's probably one of three reasons driving this:

You've received a Job Offer

You've just received a job offer, and now need to decide on whether to set up a limited company, umbrella company or become a sole trader (or you may not have the choice in deciding).

You're in the right place.

This guide will walk you through the best company structure for you, accounting support, VAT, business services you need to consider and finding new opportunities.

You want to increase your pay

You'd like to increase your pay by switching from permanent roles to interim/ contractor roles.

Contracting can be very lucrative.

You'll need to be comfortable with a certain level of risk (short notice periods), increased monthly admin (as a Limited Company) and less benefits than being an employee (paid leave, sick days).

However, you'll earn more, get greater flexibility and hopefully grow a consulting business.

Project Flexibility

Getting multiple requests for your services? Amazing.

Setting yourself up as a contractor through a Limited Company means you can start expanding your client base rapidly and work on different projects a few days a week.

You can still set this up as a current PAYE employee of a company, and this can be a great stepping stone to launching your own business.

Let's talk about the right business structure for you.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

What is a Contractor?

You've been thinking about making the leap from employee to self-employed. If contracting is one of the options you're considering, this article is for you.

We'll run you through the basics, including what it means to be a contractor, how it differs from full-time employment and the type of business structures that contractors typically choose.

Contractors are self-employed individuals who provide services to a business. Generally, they're highly skilled, and are hired for projects that require specialist skills or to bolster a team during busy periods.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

When do I need a Limited company as a contractor?

There is no clear cut time as to when you should start working through your own limited company. With other routes available-such as operating as a sole trader, or working through an umbrella company-it is always worth weighing up what is best for you and your circumstances.

With that being said, if you plan to work as an independent contractor for the foreseeable future, opening your own limited company at the early stages can maximise your opportunities for reaping the benefits of having your own company straight away.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

What are the different types of contractors?

There are different types of contractor jobs available across diverse sectors. Contractors may be hired to perform services such as:

  • Marketing
  • IT maintenance and support
  • Graphic design
  • Recruitment
  • Business development
  • Catering
  • Construction work
Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Self Employed Registration Guide

  • What is a Sole Trader?
  • Sole trader advantages
  • Sole trader disadvantages
  • How to register self employed
  • Sole trader responsibilities
  • Self employed tax
  • Important self employed deadlines
Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

How to Start Contracting Guide

  • What is a contractor
  • Types of contractors
  • Contractor business structures
  • Contractor accounting
  • Understanding IR35
  • Contractor insurance
  • Banking for contractors
Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

How to set up a Limited Company

When you set up a limited company, you'll enjoy many advantages you don't get as a sole trader. Not only is it a tax-efficient way to run your business, it's also a great way to limit your personal liability and increase your credibility with customers. Additionally, it could open new avenues of work that wouldn't be open to you if you were operating as a sole trader, especially some contractor roles.

One of the disadvantages of running a limited company is that it involves a lot of paperwork, but with the help of this guide, we'll clear away the jargon and tell you exactly what you need.

If you're unsure about whether a limited company is right for you, check out our handy article comparing the differences between Limited companies and Sole Traders to see which business entity is right for you.

If you've got more important things to do than dealing with extra admin, you can always take advantage of one of our accountancy packages and we'll do all the forms and applications for you.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

5 advantages of a limited company

The advantages of operating as a limited company are well known. It can be a great way to maximise your take-home pay, improve your credibility with customers and limit your personal liability. Like most things in life, it's a case of what's best for your situation. While the positives outweigh the negatives for most people, there are a few things you should know before you make the jump to a limited company.

In this article, we'll outline the disadvantages of operating as a private limited company. Bear in mind that there are many advantages to a limited company and in many cases, these advantages will outweigh the disadvantages, so don't think of this as a report of doom and gloom.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

What are Personal service companies?

While there isn't a legal or formal definition of the term, personal service companies (PSC) refer to limited companies that are owned by a contractor, who is also the only shareholder and sole director. In some instances, the company may also be owned by a very small group of individuals.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

What is an independent contractor?

An independent contractor is an individual who is engaged in a work agreement with a company or entity as a non-employee.

Factors that identify an independent contractor are:

  • They have a greater degree of control over their work
  • They offer a special skill set
  • They are able to get a replacement
  • They aren't entitled to employment benefits
Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Umbrella vs Limited Company

Let's compare the advantages and drawbacks of setting up a limited company VS working through an umbrella company.

Why set up a limited company?

  • Limited liability
  • Tax efficiencies
  • Increased credibility

Why not set up a limited company?

  • Increased legal and administrative requirements
  • Less privacy; details of the company are publicly available

Why work through an umbrella company?

  • Ease of use
  • Flexibility
  • Entitled to statutory benefits

Why not work through an umbrella company?

  • Costly way to operate
  • Lack of control
Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

When do I need a Limited Company?

There is no clear cut time as to when you should start working through your own limited company. With other routes available-such as operating as a sole trader, or working through an umbrella company-it is always worth weighing up what is best for you and your circumstances.

With that being said, if you plan to work as an independent contractor for the foreseeable future, opening your own limited company at the early stages can maximise your opportunities for reaping the benefits of having your own company straight away.

Read Full GuideRead Full GuideCalculate Now

Download Now:

Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Registering a Limited Company Guide

Speak to an Accountant