From sole trader to company: Is it time to change your business structure?

Is your business growing? Are you ready to take on new challenges?

It might be time to change your business structure and take the leap from sole trader to company.

Here’s what we cover in this article:

• What are sole traders?
• What are companies?
• The benefits of becoming a company
• 8 steps to take to become a company
• What next?

What are sole traders?

A sole trader runs a business as an individual.

If you’re a sole trader, you are ultimately responsible for all of your business’ decisions and you have unlimited liability (ie you, as an individual, are liable for any losses or debts that your business takes on).

Sole trader is often a good legal structure to use when you’re starting a new business.

Operating as a sole trader can help you get your business off the ground with fewer administrative and legal formalities that need to be met than if you are, for example, starting a company straight away.

What are companies?

A company is a business which is its own distinct legal entity.

This means that it’s legally considered to be a separate ‘person’ to you. You may run your company as a director, but the company exists beyond your control of it.

For example, as a director, you’ll be running your company on behalf of the company’s shareholders rather than for yourself.

If you were to cease being a director the company would continue without you.

The most common type of company in the UK is a private company limited by shares (ie an ‘LTD’). LTDs are owned by their shareholders.

They’re run by directors who are authorised to act on the company’s behalf and who owe legal duties to the company and its shareholders.

These authorities and duties are mostly granted and imposed by the Companies Act 2006 and the company’s articles of association (ie its constitutional document).

More knowledge and admin are required to run a business as a company than as a sole trader.

However, investing in these things is often a worthwhile exchange for the power and malleability that a company structure can bring to your business.

The benefits of becoming a company

Running your business as a company offers many advantages that you can utilise to efficiently grow and develop your business.

These include:

Scalability

Becoming a company can make it easier to efficiently increase the size and scope of your business by making capital easier to come by.

Unlike a sole trader, a company can issue shares (ie equity) to investors. Owning part of a company, with the prospect of sharing in its future successes, can appeal greatly to investors who want higher returns on their investments.

Having a company structure can also help attract investors, as starting a company can help to signify your serious and ambitious commercial intentions.

Moreover, selling shares in your company brings new shareholders into your company’s community.

During this process, you may also bring on board new expertise and perspectives if new shareholders become actively involved in the running of your business.

Angel investors or venture capital firms, for example, will often offer such resources alongside capital.

New perspectives and expertise can help you confidently steer your business in new directions and, consequently, to scale it up and out.

Limited liability

The shareholders of an LTD have limited liability.

Shareholders’ liability for debts or losses that the company faces are limited to the amount (if any) that is unpaid on their shares.

This essentially means that, if the company becomes insolvent and must pay out a sum of money, the shareholders are not liable for this amount beyond the amount unpaid on their shares (their liability is limited).

This effective separation of personal and company finances protects shareholders (usually including directors) if the company makes large losses.

This means there is less personal risk (than there would be for a sole trader) if you take risks to lead your company down innovative new commercial paths.

Be aware, however, that company directors may sometimes be personally liable to creditors (ie people to whom the company owes money) during insolvency.

This occurs when a director has, for example, been involved in fraudulent or wrongful trading (eg by continuing trading and taking on debts once it’s clear that the company isn’t going to avoid liquidation).

8 steps to take to become a company

If you decide it’s time for your business to become a company there are various steps you must take to ensure that you follow the legal requirements for setting up a private limited company.

These steps include the following:

1. Choose a name for your company

Various rules apply to how you can name a company.

For example, your name must not be the same as or too similar to any other company’s name. It should also usually include ‘Ltd’ or ‘Limited’ at the end of the name.

Your name shouldn’t infringe on anybody’s intellectual property rights and shouldn’t contain offensive or sensitive words.

Remember that this is only your company’s name – your business can trade under a different name.

2. Choose the best type of company for you.

Private companies limited by shares are the most common type of company in the UK for commercially oriented businesses.

If you’re a certain kind of organisation, for example a not-for-profit, a private company limited by guarantee (which is financially backed by guarantors rather than shares) may be more appropriate.

3. Choose a registered office address

This is where all written correspondence for your company should go. It must be a physical address (including PO boxes) in the same country in which your company is registered (eg in Scotland if your company is registered in Scotland).

Your registered address is publicly available information. If you don’t want your address to be known you can appoint an agent and, with their agreement, use their address.

4. Appoint directors

Directors are the people who run a company, within the rules set out in the company’s articles of association.

They’re responsible for planning, decision making, and ensuring that the company meets its legal obligations (eg reporting obligations).

Directors are ‘office-holders’, meaning they owe legal duties to the company and its shareholders. For example, the duty to use reasonable care and skill when leading the company.

A company must have at least one director. The company’s articles of association should set out how directors can be appointed or removed.

5. Decide how many shares to issue and at what value

You must issue at least some shares (ie equity) in your company, even if 100% of the shares in the company are issued to you, and you’re a director. 

Shares are owned by shareholders, who have the power to vote on company decisions (eg whether to appoint somebody as a director).

You can issue shares in exchange for capital, which can be used to help grow your business. This process should be formalised using a Shareholders’ Agreement and Share Certificates.

6. Create a company constitution

Also known as ‘articles of association’, a company constitution is the legal document that sets out the rules by which the company should be run.

The articles generally cover decision making powers, appointing and removing directors, share dealings, and administrative matters.

Companies House provides model articles that can be used. Some people, however, choose to make articles of association tailored to their business’ needs (eg to allow for multiple different classes of shares).

Any modifications must not take the content of your articles outside of what’s permitted by the Companies Act 2006.

7. Check what records your company must keep

Companies are legally required to keep various records. These should usually be kept at your registered address.

Important records you must keep include details of your directors, the outcomes of shareholder votes, and information about transactions and debts.

You must also keep various accounting records, including details of the company’s full income and outgoings, debts, stock and assets owned, and goods bought and sold.

Further, a register of ‘people with significant control’ (PSCs) must be kept.

PSCs are people who hold more than 25% of the shares or voting rights in your company or who can appoint or remove most of your directors or otherwise influence the company.

8. Register your company with Companies House

Once registered with Companies House, you’ll be legally operating and publicly recorded as a company.

To register, you’ll need most of the information and documents from above (eg articles of association, a registered address, and information about PSCs). You can usually register online and can register for Corporation Tax at the same time.

The UK government provides more complex guidance on how to set up a limited company.

What next?

If you decide to run a company, you’ll have access to all of the benefits associated with the LTD legal structure. However, if you’re in charge, you must make sure to keep up with your legal responsibilities as a company director.

You’ll need to pay more complex taxes, stay accountable to shareholders, follow your company’s rules and the law, and keep up with HR and accounting administration and reporting requirements.

Cloud accounting software and HR software can help you to manage these obligations.

If you require assistance or advice on changing your business structure from sole trader to company, consider speaking to an expert, such as a chartered accountant or lawyer.