Difference between a Sole Trader and a Limited Company

"Business opportunities are like buses, there's always another one coming."
- Richard Bronson, founder of Virgin Enterprises

If business opportunities are like bus, then be sure that there will be many who will want to board the buses. They will also face the eternal question 'What next'? The next step is to choose the type of business. The choices are many and the decision, well, as usual, always difficult to make.
Before opting for any type of business, it will augur well, if you understand the difference between each of the options.

Sole trader:

Sole trader is a person who carries out the trade/ business single handedly. He is the whole and soul of the business. Usually, there is no one to assist him; though in some cases he might keep an assistant or a helper.

The following are the distinguishing features of a sole trader:

1) He is responsible for the entire business. He is responsible for all the affairs pertaining to the business.

2) The law does not make any distinction between the owner and his business. In the eyes of the law, both the owner and his business are the same.

3) Since the law does not distinguish between the owner and his business, his liability is unlimited. For e.g. if the business goes bankrupt, the owner will have to cough money from his own assets and financial reserves to pay to the creditors and lenders.

4) The sole trader is also liable to pay for any legal compensation that might arise in the course of running the business. He cannot shrug his responsibilities. He will not be able to defend himself by saying that the act was committed by his business and not by him.

5) The sole trader has the final say as far as decision-making is concerned. He is not legally bound to listen to anyone. He may do whatever he deems to be fit.

6) Since he has the freedom to take all the decisions, he is also responsible for them. For e.g., There is a bread manufacturer, [who is also a sole trader], who introduces a new variety of bread, thinking that there is demand for this particular variety. If the product succeeds, he can take the credit. If the product fails and as a consequence he suffers losses, then he will be held for the losses. The buck starts as well as stops with him.

7) He keeps the entire profit earned by him. Similarly he also has to shoulder the entire burden of loss.

8) A sole trader has to maintain financial records that distinguish between money used for personal and business purpose. For e.g. if he sends a letter to his wife, the postal expenditure will be treated as personal. But if a letter is sent to a prospective customer, it will be treated as expenditure incurred for business purpose.

9) A sole entity might come to an end if the owner becomes bankrupt or has an untimely demise, with no one to look after the business.

Limited company:

A limited company is a separate entity and is also either registered or incorporated under the laws of the country in which it is situated. It is a separate person in the eyes of the law.

The following are the distinguishing features of a limited company:

1) Since a limited company is a separate person, it can hire 'employees'. These employees are responsible for running of the company. These employees can be the directors of the company, the secretary as well as the staff including the receptionist!

2) For setting up a limited company, most of the countries require registration. Some countries also specify the minimum number of people that are required to start a limited company.

3) The laws of almost all the countries specify the use of the word 'limited ' or 'ltd' after the name of the company.

4) The finance for starting a limited company is raised by issuing shares. The people to whom the shares are issued are termed as shareholders. The shares cannot be issued to the general public unless it is a public limited company.

5) The liability of the shareholders is limited to the amount paid by them during the purchase of the shares. For e.g. if the company goes into debts, they are not liable to pay to the lenders and creditors from their own personal finance.

6) Similarly even the directors and other staffs are not responsible to pay. This is because the company is a separate entity.

7) The directors are responsible for the health of the company as well as its day-to-day affairs.

8) But if the company is held for any wrongdoing, the case will be filed against the company and not the directors. However, the directors are responsible for the way the company is run. If evidence of wrong- doings is found against the directors, cases can be field against them in the court of law.

9) The directors, in consultation with the shareholders, take the decisions pertaining to the company. Meetings such as AGMs [Annual General Meeting] are held to discuss about future strategies and growth plans.

10) The profits earned by the company can be distributed among shareholders as dividend. Alternatively, it can be also used for the expansion plans of the company.

11) No single person owns the company. It has a perpetual existence, which is not affected by the death of any shareholder or director.

Though there are many distinguishing factors the main difference between a sole trader and a limited company is that the law makes no distinction between a sole trader and his business, whereas a limited company is a separate entity in itself which can function very much like humans i.e. it can hire people, sue and get sued etc.