Trading and investing for beginners: Should I trade through a business entity or as a sole trader?

If you’ve decided to get into trade or investment in the UK and you’re struggling to figure out how to get set up, this article provides a good outline of 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 something known as limited liability insurance. This is a type of insurance that protects an individual’s 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. It means that 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 normally works out at the amount you paid for the shares on top of any 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 director of a limited company, you pay yourself a wage through dividends. Dividends are only subject to tax if you earn more than £2,000 or if you 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 full 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 a sense of 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 is required to have a Legal Entity Identifier which is used in each trade to track the entities in each transaction.

Access to finance

In the long run, it’s much easier to access finance through a business entity. You can get a loan much more easily, and you can 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) and you can do it for less than £20 and in less than 10 minutes.