Being a sole trader: the advantages and disadvantages

If you’re thinking about starting a business in the UK, one of the first few things you need to consider is business structure. Before you decide which business structure to choose, you should have a full understanding of the benefits and drawbacks of each.​

In this blog, we’ll explain what a sole trader is and its advantages and disadvantages.​

A sole trader is one of the common business structures for small businesses in the UK. It is the simplest and cheapest business structure. A sole trader is an individual running a business. If you operate your business as a sole trader, you are the only owner and you control and manage the business. ​

The other common business structures are partnerships and companies. ​

As a sole trader, you’re responsible for paying your income tax and VAT (if you’re VAT registered). Many small business owners choose to change their business structures to companies or partnerships as their businesses evolve. This may have implications on how you run your business, your responsibilities, tax obligations and more.​

One of the key advantages of being a sole trader is that you can be your own boss. This means you dictate the direction of your business and are accountable to yourself. This might be the biggest reason why people ditch their 9-5 jobs to become a sole trader.​

A sole trader has more freedom with decision-making compared to other business structures. For example, if you operate your business as a partnership, your partner will likely be involved in making business decisions and setting the direction of the business.​

To set up as a sole trader, you need to:​

Depending on your industry, professional licenses and business permits (if needed), or qualifications or registrations for your trade or profession may be required. A separate bank account for your business is advisable to keep your personal and business finances separate. You might also want to pay for a cloud-based accounting software such as Xero. Therefore, for sole traders just starting out, low costs and ease of setup are appealing. You can switch to other business structures as you grow your business (we’ll cover this later). ​

From a company perspective, once established, a company is more costly to run. With greater compliance requirements, this results in more paperwork and fees.​

Another advantage of being a sole trader is that you can keep all the profits after tax on your business.  However, if you are running a business through a partnership or a company, this means you may need to share the profits with your partner or shareholders.​

If you want to start small and expand your business later on, being a sole trader allows you to do so. Changing to other business structures (e.g. partnership or company) is fairly easy because you don’t have to go through the process of dissolving and stepping down from your business. Depending on the type and size of your business, a company may be better suited for a variety of reasons, in particular relating to tax savings.​

One of the biggest disadvantages of being a sole trader is you will have unlimited liability. When you’re operating as a sole trader, you and your business will often be seen as one entity. This means there’s no protection for your personal finances and assets. You’ll also be responsible for the debt your business incurred - the worst-case scenario is that you could lose your house to pay off your business’ debt! As a result, being a sole trader may come with its own set of risks.​

If you’re planning to scale your business, taking on investors or large clients, it will be easier if your business is a company.​

Another disadvantage is the challenge of growing your business when it comes to securing funding to facilitate the growth of your business. Sole traders as a business structure are the most ideal for small businesses that require minimal funding. Therefore, you may consider changing your business structure (e.g., to a company).​

Full control over your business can be an advantage, but also a disadvantage. You must make all business decisions and are solely responsible for the decisions you make. It can be stressful sometimes because the business is reliant on you. If the business fails, you’ll be taking full responsibility. ​

A sole trader business structure is taxed as part of your own personal income. You can find the personal income tax rates here. However, companies are taxed at a flat rate between 19% and 25% in the UK. There is no tax-free threshold for companies – you pay tax on every pound the company earns. ​

Depending on the kind and size of your business, sole traders may be less flexible when it comes to working around the tax system. For example,  sole traders are taxed as individuals and individual marginal tax rates can go as high as 45% so the more you earn, the more tax you will be paying at the higher marginal tax rate. In instances where you could pay less tax by operating as a company, your business advisor may recommend that you do so. ​

Being a sole trader could make it harder to sell when you want to sell and exit your business. This is because your business and you are seen as one entity. In other words, your business is often linked with your personal assets.  Therefore, if you wish to sell your business, you should consider switching to the company structure.​

Choosing a business structure that suits your business and personal circumstances is crucial in the startup phase. Many small businesses choose to operate under the sole trader structure in the beginning because it’s easy to set up and minimal paperwork is required. However, sole traders are not the best business if you wish to grow your business. Not only will you have unlimited liability, which means you’ll be personally liable for all business debts, but as your business becomes more profitable the sole trader structure becomes less tax efficient.​

We’re an online accounting firm that is always right here for you, your accounting pain relief. The most advanced technology lets us work way more closely with you than a normal accountant world. ​​

We have a dedicated team of certified accountants and a support team to take care of your business no matter where you are, so you can focus on growing your business. We take out the ‘fluff’, break down the barriers and get things done. Looking out for you is what we are all about. Register today.​