Company vs sole trader: What's the verdict?

When registering your business, you need to decide which business structure you'll adopt. There is no right or wrong answer here. You’ll need to carefully consider your business and industry, and adopt the structure that is most appropriate for you.

One of the most important aspects of informing your decision is whether to register yourself as a sole trader or a company. So, what’s the difference between the two?

A Proprietary Limited Company (Pty Ltd) is a business structure with at least one shareholder (owning the company) and one director (running the company)—which are often the same person. On the other hand, a sole trader is a structure where the person operating the business is the individual legally responsible for all aspects of the business.

Essentially, a company structure has many advantages over a sole trader structure. Let's look at why:

Tax

• As a company, you will be taxed as a separate entity under a company tax rate of 30%. The revenue of the business will be taxed at this rate, and then kept in the business to assist growth unless you decide to distribute the income to the owners/shareholders.
• As a sole trader, you will be taxed as an individual, with your business simply being an extension of your personal income. Your business profits will be aggregated with any other personal income and you will pay tax on that sum.

The key reason that a company structure is preferable here is that it offers flexibility. If your business becomes quite profitable, you have the option to keep the profits within the business in order to allow your business to grow.

Alternatively, as a sole trader, the revenue is added to your yearly personal income (potentially being taxed at a higher rate as you move into higher tax brackets). A company structure gives you more control over your tax outcome.

Liability

• Under a company structure, the company is taking out a loan, rather than you as a director. In the case of default, the lender can go after the company’s assets but your personal assets are protected. An important exception to this is where you have signed a director’s guarantee over the loan.
• Comparatively, as a sole trader you secure debt under your personal assets (as the business and the owner are treated as the same thing) therefore your creditors will be able to pursue your personal assets in order to recoup losses if you default.

Your personal possessions will be more secure under a company structure, provided you haven’t signed a director’s guarantee.

Raising money by offering equity

• As a company, you are able to raise money by offering equity in the business in return for investment.
• Sole traders are unable to raise funds in this way as the business is considered part of the owner’s personal assets.
• A sole trader may want to offer a partnership in their business, but even this has the disadvantage of requiring personal property as security. A company structure provides a clear mechanism for scaling the business if that’s your longer-term goal.

Transfer of ownership

• A company has ‘perpetual succession’ which means that the business can continue to operate even if the founders pass away, due to the fact that the business is seen as a separate entity.
• Transferring ownership as a sole trader is a lot more difficult. Usually, when the owner passes away, so will the business. Given that the business is tied to the owner’s personal assets, they are subject to whatever is dictated by the owner’s will.

Long story short—the transfer of ownership is always easier under a company structure.

Paperwork and establishment costs

• As a sole trader, you only need to pay for business name registration and the renewal every 1-3 years.
• Setting up a company requires business name registration, as well as company registration and reservation of a company name. Each of these has associated costs, and company registration can be expensive.

Paperwork is never fun, and registering a company requires a significant amount of paperwork. The establishment costs for a company are much greater than that of a sole trader. Conversely, the setup time and expenses associated with establishing yourself as a sole trader are relatively low.

The verdict?

While registering a company involves more paperwork and greater upkeep costs than registering as a sole trader, being a proprietary limited company has many advantages. It is favourable in the areas of tax, debt security, equity investment and transfer of ownership. In the longer term, a company structure is preferable on many fronts. Keep in mind that some lenders are reluctant to deal with sole traders as they prefer the security and organised structure that a 'company' provides.

If you're currently operating as a sole trader, it could be a good idea to seek independent accounting advice prior to making any changes to your business' structure.