Most founder tax mistakes are made in the first two years and discovered at exit. The expensive ones are structural: shares issued without thinking about relief, an EMI scheme set up too late, a convertible loan note that quietly disqualifies investors from relief, and a shareholding that fails the 5% test the year before a sale.
Sole trader or company
Model it, do not assume it. A company pays corporation tax at 19% on profits up to £50,000 and 25% above £250,000, with marginal relief between — an effective rate of about 26.5% inside that band, which is higher than the main rate and catches founders by surprise.
Extraction then costs again: dividends at 10.75%, 35.75% or 39.35% with a £500 allowance, or salary through PAYE with employer National Insurance at 15% above a £5,000 threshold.
As a sole trader you pay income tax and Class 4 National Insurance on profits as they arise, with Class 2 now treated as paid rather than charged where profits exceed the small profits threshold.
At modest profits the difference is small and the extra compliance eats it. As profits rise — particularly where some can be retained rather than drawn — the company gets ahead. And the non-tax factors often decide it anyway: limited liability, the credibility of a company number with larger customers, and the ability to bring in a shareholder. Our guide for the sole trader position covers the compliance side.
Get the share structure right at the start
This is the single highest-value hour a founder can spend, because almost nothing here can be fixed later.
Business asset disposal relief taxes qualifying gains at 18% on the first £1 million, and its conditions are tested for two years before disposal. You need 5% of ordinary share capital and voting rights, and a matching 5% of economic entitlement — either 5% of distributable profits and assets on a winding up, or 5% of proceeds on a sale of the whole ordinary share capital. You must also be an officer or employee throughout.
Three traps follow. Alphabet and growth share structures frequently satisfy the share capital test and fail the economic entitlement limb. A founder diluted below 5% by a funding round loses the relief unless a dilution election was made at the time. And a founder who resigned eighteen months before the sale has lost it with no remedy at all.
The exception worth knowing: shares acquired under an EMI option are outside the 5% test entirely.
EMI, and why timing matters
An enterprise management incentive option granted at market value produces no charge on grant or exercise, and capital gains treatment on sale. For a company that cannot pay market salaries, it is the most effective retention tool in the system.
The limits: gross assets up to £120 million, fewer than 500 employees, an individual limit of £6 million, and the company must be within 15 years of its first qualifying trade. A working-time declaration is no longer required from the employee, though the working-time test itself remains.
The reason to act early is valuation. Options granted at market value when the company is worth little carry almost no cost; the same options granted after a funding round carry the post-money value. Founders who defer a share scheme until "things settle down" pay for the delay in the exercise price.
The convertible loan note trap
This one costs investors their relief and founders their goodwill, and it is entirely avoidable.
A convertible loan note fails the cash-subscription requirement for SEIS and EIS. Money advanced as a loan and later converted is not a subscription for shares, so the investor does not get relief on it.
An advance subscription agreement can qualify, but only if it is genuinely a subscription rather than a loan: the money must be non-refundable in any circumstances, carry no interest, and have a longstop by which shares must be issued. On that longstop, HMRC's stated expectation when considering advance assurance is no more than six months — which is an expectation rather than a statutory condition, but going beyond it means losing the comfort of assurance.
If investors are expecting relief, the instrument has to be right before it is signed. Our guide to convertible loan notes sets out the distinction.
The compliance floor
Four things that generate avoidable cost:
- The cash basis is now the default for unincorporated businesses, with accruals requiring an election. It is usually wrong for a business carrying stock or giving real credit — and the old objection about losses has gone, since the bar on sideways relief was repealed from 2024/25;
- Payments on account catch almost every sole trader in their second year, when eighteen months of tax falls due in one January;
- Making Tax Digital for income tax is live, phasing down from the highest band to £30,000 in April 2027 and £20,000 in April 2028;
- Director identity verification now blocks acceptance of a company's confirmation statement until every director has verified. A company that leaves it to the filing deadline cannot file at all.
And one that catches growing groups: the £50,000 and £250,000 corporation tax limits divide by the number of associated companies plus one. A dormant sister company or a separate property company can push a profitable trade from 19% into marginal relief.
Director's loans
Founders take money out informally and formalise it later. Two figures make that expensive. An overdrawn loan outstanding nine months and a day after the period end attracts a section 455 charge at 35.75% for loans made on or after 6 April 2026. And a balance over £10,000 creates a taxable benefit unless interest is paid at the official rate of 3.75%.
Note the direction, because it is commonly reversed: the company is the lender, so it is the director who pays interest to the company, and the receipt is company income.
The sequence that works
Decide the structure before trading rather than after. Fix the share classes and the economic entitlement before the first investor. Grant options while the valuation is low. Get the investment instrument right before money moves. And diarise the associated companies question every time a new entity is formed.
Acumon works with founders through startup accounting, business tax and EIS and SEIS advice, with valuations for share schemes and cloud accounting underneath. If you are raising money in the next six months, the share structure and the instrument are the two things to settle before term sheets circulate.