Small businesses are the backbone of the UK economy. It is estimated that at the start of 2018, there were 5.6 million small businesses, accounting for over 99% of private sector businesses, according to figures from the Federation of Small Business. Of these around 3.4 million operated as sole traders, or 59% of the total number of small and medium sized enterprises (SMEs).
In this article we examine what a sole trader is, and the advantages and disadvantages of setting up as a sole trader.
A sole trader is someone who runs their business as an individual. There is no legal distinction between the individual and the business.
It does not mean that they necessarily operate alone, as many sole traders employ staff to work for them. It simply means that they are legally and personally responsible for all aspects of the business, from losses, to bills, to accurate record keeping, and any failure to meet those obligations will affect the business owner personally. It also means that any profits belong entirely and solely to the business owner.
The advantages of being a sole trader
One of the advantages of being a sole trader is the ease with which you can start your business. There’s no need to register your business name or register with bodies such as Companies House. All you need to do is notify HMRC within three months of setting up that you’re going self-employed.
Another advantage is that you’re in sole control of your business. There are no partners or directors to report to or consult with, so you can respond quickly to the needs of your customers, and create the company to meet your vision.
Rather than have to split and share profits with other people, as you would in a partnership for example, all the profits are yours to keep. And there’s no complicated accounting processes involved. Simply keep a record of all incomings and outgoings and you’ll be fine.
It’s easier to change your mind
When you start a business there are a lot of unknowns. Setting up as a sole trader is a great way to dip your toes into the business world before committing to setting up as a limited company with all the additional obligations that that brings. Should your business grow, along with your confidence, you can always register as a limited company at a later date.
A limited company has more legal obligations to meet than a sole trader. They are required to produce detailed annual accounts, for example. While a sole trader must report their income and expenditure for their self-assessment tax return, it’s a much simpler process. In addition, your financial information is kept private, unlike with a limited company, where it can be viewed by anyone.
Disadvantages of operating as a sole trader
Under UK law, sole traders and their business are viewed as one and the same. Therefore they have unlimited liability should something go wrong. For example, should your business get into debt, a sole trader is legally obliged to pay off those debts using their personal assets, which could include their home.
All business ventures require investment, however small that may be. But to grow a cash injection is often needed. Sole traders often find it difficult to raise finance to fund their business, as banks are less willing to lend to them, and investors more reluctant. Even if you are able to secure funding, it may well be far short of that you could secure as a limited company.
Whether it’s deciding to take the business in a new direction, or meeting your obligations to HMRC, a sole trader carries all the responsibility on their shoulders. While you may have moral support from friends or family, ultimately all decision making is down to you and you alone, and you are the master of your own destiny. That can be a scary prospect.
Problems if you’re unable to work
Sickness and accidents happen. That’s life. But when you’re a sole trader, your business stops if you can’t work. Sole traders should consider in advance what they would do should the worst happen, and if and how they could continue to trade.
Difficulty securing larger contracts
Even if you have employees, it can be difficult to get others to see you as a serious contender for larger contracts when you’re classed as a sole trader. Limited companies are more likely to be taken seriously, even if they have the same number of staff. This can make it difficult to grow your business.
Anyone wanting to set up in business should carefully consider the form that their business will take. As can be seen, when choosing whether to setup as a sole trader or limited company there are a number of advantages and disadvantages of both that should be taken into account.