One of the common questions I get asked when some-one wants to start a business is which
business entity should they use?
Sole Trader or Limited Liability Company?
In this video I will talk about some of the differences between the two entities and this
should help you decide which is the best option for you.
When most people have decided to set up their own business, the first issue they encounter
is the question: "Should I operate as a sole trader or start my own limited liability company?"
There are many factors to consider and many advantages and disadvantages to setting up
as either.
The decision often depends on the personal preference of the person who owns and runs
the business and the type of goods or services that they are providing.
There is never one standard answer for all businesses.
Here are some basic definitions describing a Sole Trader and a Limited Liability Company.
A sole trader operates a business on their own. They can employ people, but the trader controls,
manages and owns the business and is entitled to all profits.
This person is fully liable for the company's debts and contracts and there is no distinction
in law between the business and them, the trader.
Usually, a sole trader business can be established without any paperwork.
A Limited Liability Company, is a formal and legal entity in its own right
and separate from its owners, shareholders or directors.
Shareholders' liability for losses is limited to their share of ownership of the company.
The company is run by directors who act on behalf of the shareholders, although in most
small businesses this may be the same person.
The limited liability company is New Zealand’s most successful business structure.
I have included up here, and in the description below the links to two videos that you should
watch for a better understanding of each entity.
One of the biggest benefits of having a limited
company structure instead of operating as a sole trader is that with a limited company
you have limited liability.
A sole trader will be completely responsible for the business and its finances.
A sole trader, the business owner and the business are treated as one.
With a limited company the business itself is a separate entity in the eyes of the law.
Business debts are the personal responsibility of the sole trader whereas they stay within
the limited liability company.
If the business goes bust the personal finances and assets of the sole trader are in danger.
This is because legally there is no difference between the sole traders assets and the business’
assets.
As well as finances, this will also apply to any legal disputes.
A sole trader will need to have various comprehensive business insurance policies in place to avoid
getting sued personally.
In the eyes of the law, the sole trader and the business are the same.
No-one wants to pay more tax than is necessary.
A limited liability company has an advantage over sole traders insofar as a company is
more tax efficient.
Being a limited liability company enables accountants to structure the business affairs
to save on income tax, and utilise other claimable expenses.
The use of dividends and sensible payroll planning often mean that the business owner
can make substantial tax savings.
At the end of each financial year both a sole trader and a company must complete a tax return
and submit it to Inland Revenue.
A limited company may come across to businesses
as a better model to work with than a sole trader.
Businesses, contractors, clients etc. are more likely to work with a limited company
as their perception is that a limited company is more professional.
A limited company can build a good reputation, which makes it more credible, and more saleable
when the time comes to move on.
Both sole traders and companies will need
to prepare accounts and submit a tax return each year.
There may also be a need to submit GST and/or provisional tax returns, depending on the
size and amount of revenue the business has.
The company directors must also ensure that the company complies with the Companies Act,
including keeping a company register and maintaining the relevant records.
As a result, accountancy and administration costs are likely to be higher for a limited
company than a sole trader.
It is important that you get the right advice especially when it comes to tax and financial
matters.
I strongly suggest you talk to an accounting professional to help you get it right before
you decide which is right for you.
A sole trader legal structure for a business is the easiest to set up and that’s why
it has been proven to be such a popular option.
However, there are clear advantages to running your business through a limited company structure.
Before deciding, it’s important that all factors are considered.
Ensure that you have weighed up the pros and cons of all legal structures to see what fits
you and your business best.
Thanks again for watching.
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Until next time.
See you then.