Thinking of Switching from Sole Trader to Limited Company?

March 9, 2017

Thinking of Switching from Sole Trader to Limited Company?

We recently dealt with a corporate insolvency that perfectly highlights the potential pitfalls of not properly planning and implementing the transfer of your business from sole trader to a limited company.


In this blog, I’ll look at the particular case, pick out some common mistakes that business owners make every day and explain how you can avoid making them too!

First, though, some background.

For years, our client had operated his business as a sole trader. However, attracted by the appeal of prestige and the limited liability protection of a limited company he decided to incorporate his sole trader business.

Unfortunately, he failed to take appropriate advice and failed to implement it properly. The list of failings included poor or non-existent record keeping, continuing to operate as both sole trader and limited company, not engaging openly with suppliers and customers and not having sufficient financial resources in place.

Since our client’s limited company was a new legal entity, it had no trading history, which, in turn, made it difficult to obtain credit from suppliers in the short term.

Unfortunately, our client had not planned for this cash flow issue and had not set aside appropriate finances to fund short-term lack of credit. The business owner never engaged with his suppliers about the new business structure and continued to obtain supplies on credit as the sole trader on behalf of the limited company.

His trading and finances were so muddled and intertwined that even the business owner couldn’t distinguish between the sole trader and the limited company and and his suppliers often thought they were still dealing with him personally as a sole trader when they were actually dealing with the limited company.

In the end both the company and the business owner went into insolvency. The business owner will lose everything, including his business, home and reputation.

In the remainder of this article, I will look at the mistakes our client made and what he could have done differently.

If you are considering moving from a sole trader to a limited company structure or have already done so, please read through this article carefully as it could quite possibly save your business and your home.

What is the difference between a sole trader and a limited company?

One of the first decisions business owners must make is deciding what structure their business will take. The two most common options are either:

  • Sole Trader, or
  • Limited Company

With sole traders, the individual and the business are the same legal entity. You are the business. While this is great for simplicity and generally results in less admin, it means the business owner personally shoulders financial and legal liability for the business’ debts.

If anything goes wrong with a sole trader business, the owner is personally liable for all business debts, which could put all their personal assets at risk.

A limited company, on the other hand, is a completely separate legal entity owned by the individual. The headline advantage of a limited company is limited liability. Limited liability means it is normally the company that bears all legal and financial responsibilities with no personal liabilities attached to the shareholders.

If a properly run limited company gets into difficulty, the business owner’s personal assets should not be at risk.

The differences between a sole trader and a limited company are significant and can have long-lasting effects if anything goes wrong.


Sole Trader

Limited Company

You are the business

You bear all legal and financial responsibility

Cheaper and easier to set up and run<

The company is a separate legal entity

The company bears all legal and financial responsibility*

Greater administrative burden and costs involved in setting up and running


The general idea of limited liability is to protect the people behind businesses but it only works if the company structures are set up and run properly.

Common mistakes when moving from sole trader to a limited company

As we mentioned in the previous section, business owners often make mistakes when moving to a limited company. These mistakes can undermine or wipe out the protection of limited liability and leave them personally liable for the company’s debts. In this section, I’ll look at some of the most common mistakes.

Confusing the two businesses

I understand that continuity is important for you, your customers and your suppliers, however, continuity does not mean confusing your old sole trader business with your new limited company. There must be a clear distinction between the sole trader business and the limited company. Ideally, the sole trader business should completely cease trading when the limited company is set up with all ongoing business conducted through the limited company.

Not planning for increased admin burden and costs

Sole trader businesses are the cheapest and simplest type of business to run with very few administrative overheads.

Moving to a limited company means an increase in the administration burden, for example, limited companies have to deal with annual returns, registered office, filing accounts, separate tax returns, and so on.

Trying to do everything yourself is often a false economy due to lost time and, therefore, you may decide to engage the services of a good accountant, suited to your style and size of business is the best way forward.

In any event, before moving to a limited company structure, I strongly recommend you obtain appropriate advice to ensure you can cope and attend to all these extra admin requirements and associated costs.

But what’s the worst that can happen? Won’t a business owner just be a bit poorer?

We were recently appointed liquidators of a property investment company that had very significant assets, no borrowings and no obvious creditor pressures. The reason for the liquidation was the business owner had simply failed to file annual returns, lodge accounts and attend to the company’s tax returns or respond to HMRC’s tax assessments.

As a result, HMRC petitioned for the company’s liquidation and all its assets had to be sold. Admittedly, this is an extreme outcome but poor administration can easily lead to fines and increased tax liabilities.

Poor paper trails

While you may get away with poor record keeping as a sole trader, it’s vital you improve your organisation when changing company structure.

Why is it so important? Well, without a good paper trail, it’s very difficult to distinguish between your old business (where you are personally liable) and your new company (where you enjoy limited liability) and that could have disastrous consequences down the line.

Not opening new accounts

A lot of business owners will continue using old sole trader business accounts even though their new limited company is an entirely different entity.

The change of business vehicle should be brought to the attention of your suppliers and new accounts opened with your new company. Your sole trader supplier accounts should be settled and closed.

Continuing with existing sole trader accounts on behalf of the new company could lead to the business owner remaining personally liable for the new company’s debts.

Additionally, you should anticipate and budget for your suppliers not offering such good credit terms, at least in the short-term while your company builds up a trading history and credit rating. Owners of new limited companies will often be asked to sign personal guarantees for new accounts.

Do not agree to personal guarantees lightly as they negate the protections granted by your limited company structure.

If you decide to proceed with such an offer, I strongly recommend you seek legal advice to ensure you fully understand the implications of the agreement.

An alternative option is to select an alternative supplier or at the very least investigate whether these personal guarantees can be for a limited amount of money or time.

Forgetting about leases

Unless you want your landlord or insurance agent springing a nasty surprise on you, it’s important to make sure the lease for your trading premises is formally transferred from your sole trader business to your new limited company. You will need the landlord’s agreement for this change which should be formally documented.

On a related note, if your limited company is now trading from your premises, you need to inform the council and ensure the rates liabilities are in the limited company’s name.

Not documenting new cash

As a sole trader, the line between you and the business is non-existant. After all, you are the business. With a limited company, however, that line needs to be clearly defined.

Ensure that any personal assets or cash that you put into the company are properly documented.

Carelessly withdrawing money

When you are a sole trader, taking money out the business is a simple matter. You are the business so the business’ money is your money. With a limited company, not so much.

How you withdraw money and what actions you take at the time are vitally important. This is the number one area where business owners get themselves into trouble and create a personal liability for themselves.

Cash should only be withdrawn either as a salary or as dividends and only when the company can afford it.

Too many business owners simply withdraw cash as they are used to doing as a sole trader without ensuring that either it is through the company’s monthly payroll with PAYE tax declared and paid monthly or taken after a dividend is declared and recorded at the time and then recorded on personal tax returns and in company’s accounts.

If you take money out of the business without due care, the best result is paying more tax than is necessary. The worst result, however, is that the company goes into liquidation and the sums you withdrew are classed as a Director’s Loan Account and you have to pay all of it back, not just the tax that wasn’t paid on these earnings.

What can go wrong?

Incorporating a business has many advantages, including the ability to raise capital, sell shares, the appearance of size, various tax benefits and, of course, limited liability.

However, as you have seen from the above, there are a myriad of mistakes that business owner can easily make.

Failure to properly understand and plan for these issues in advance of and during the move from sole trader to limited company can result in business problems, significantly increased costs and ultimately insolvency that will impact personal assets and wealth. This completely undermines the core benefit of a limited company: limited liability.

If you are considering moving from a sole trader to a limited company, please get in touch with a professional. As we have seen above, a do-it-yourself approach can easily cost you your home, your livelihood and your reputation.

Professional Indemnity Insurance – our professional indemnity insurer is Mapledown Royal & Sun Alliance plc , Mapledown Underwriting LLP, The St Botolph Building 138 Houndsditch London EC3A 7AG and policy number is RTT262119/11273. The territorial coverage is worldwide (excluding professional business carried out from an office in the United States of America or Canada) and excludes any action for a claim brought in any court in the United States of America or Canada.

GLASGOW LIVING WAGE EMPLOYERBarry John Stewart and George Dylan Lafferty are authorised to act as insolvency practioners in the UK by the Institute of Chartered Accountants of Scotland. Company Registration Number SC 477598 | VAT Registration Number 192 5146 03 | Data Protection Registration A1056203 | FCA Registration Number 766693 | Registered office: 2nd Floor Suite 148, Central Chambers, 11 Bothwell Street, Glasgow G2 6LY.