Trading and investing for beginners: Should I trade through a business entity or as a sole trader?
Suppose you’ve decided to get into trade or investment in the UK, and you’re struggling to figure out how to get set up. In that case, this article outlines the differences between a business entity account and a sole trader account to help you decide where to get started.
Protection
Setting up a limited company and a business bank account allows you to take advantage of limited liability insurance. This type of insurance protects individuals’ personal and private assets if the company dissolves or finds itself in large amounts of debt.
The limited liability law is quite old, first mentioned in 1896. It was aimed at protecting people who run the company by treating the company itself as a separate entity. Third parties contract the company itself instead of the directors or stakeholders.
If, for example, you run the company as a director, you have a capped liability for debts, which generally works out at the amount you paid for the shares on top of unsecured loans. The one exception to this is when the company loses money through fraud.
In contrast to this position, a sole trader account is not protected from any financial losses or claims. You’re taxed as both an individual and a company for admin purposes. Sometimes, sole traders have had their homes put up against their business debt.
Tax and national insurance
If you’re a limited company director, you pay yourself a wage through dividends. Dividends are only subject to tax if you earn more than £2,000 or receive tax dividends from shares in an ISA under UK law. Dividends are not subject to National Insurance Contributions.
Most company directors pay themselves a small salary and derive the rest of their income through dividends to keep tax payments to a minimum.
In contrast, sole traders pay the total National Insurance contributions on their income.
Reputation
By conducting your investment activity through your business entity, you get access to additional investment providers and counterparties. People prefer doing business with an entity because it offers security and credibility.
There are a couple of reasons for this. The first is that a business account is established, it can be transferred, and its assets may be sold.
The second is because a business account creates an ability to track and record investment activity. This leaves a trail of breadcrumbs that give hedge fund managers a way to trust you. Today, this is done because each business entity must have a Legal Entity Identifier (LEI) used in each trade to track the entities in each transaction.
Access to finance
Accessing finance through a business entity is much easier in the long run. You can get a loan more easily and raise capital by issuing new shares to shareholders and investors.
Sole traders, on the other hand, have to raise new capital from personal resources if they’re cash-strapped.
It’s easier
The final point on this is a simple one. It’s just easier to trade through a business entity. There’s a common misconception that it’s difficult to register your business, but doing so means that your business name is protected (not the case when you’re a sole trader) in less than 10 minutes.
