Why is it Good to be a Sole Trader?
Thinking of starting your own small business or going freelance? Many people choose to become a sole trader, often referred to as being self-employed. Before making your decision, what are the advantages and disadvantages of becoming a sole trader?
According to Government statistics, in 2021, 75% of British businesses were sole traders. That’s around 4.2 million businesses out of a total of 5.6m. – making it by far the most popular type of business in the UK.
In this guide, I will explore the reasons why sole trading is the most popular choice for start-up businesses in the UK, and why it might be right for you.
The Advantages of Running a Sole Trader Business
You may be surprised to learn that setting up as a sole trader is a relatively easy way of starting a business. It has fewer rules and regulations than other types of organisations. All you need to do is choose your business name, and then inform HMRC that you have decided to start a business as a self-employed sole trader, which is done via registering for Self-Assessment online.
You’ll be able to start trading right away unless you’re running a type of business that requires a licence to operate legally. If you aren’t sure about which licences you may need, you can find out using HMRC’s licence finder tool.
In comparison, registering a limited company takes much more time and substantially more admin. The ongoing reporting requirements are much more onerous. As a sole trader, you’ll have to keep accurate records of sales and expenses, but this is much simpler thanks to the fact that you’re only submitting a Self-Assessment.
This means you’ll spend less time doing paperwork and hopefully more time making a profit.
Operating as a sole trader is generally much more affordable than other routes, both in terms of start-up costs and day-to-day running costs.
As a sole trader, you don’t have to be registered with Companies House like you do if you set up a limited company, and as such do not incur the additional associated costs.
Being self-employed can also help lessen the total National Insurance contributions you have to pay.
Sole traders have fewer reporting requirements and deadlines. Accountancy costs can also be cheaper as there are far fewer statutory filings and reporting deadlines.
Sole traders keep all the profit they make for themselves. They also get to run the business as they see fit, making all the key decisions by themselves. If you’ve ever fantasized about being your own boss and like the idea of setting your own schedule, becoming a sole trader could give you the level of independence you crave.
As a sole trader, you have ownership and full control over all aspects of your business—from how day-to-day operations are carried out to the long-term goals and strategic direction of your company.
Unlike with limited companies or partnerships, you don’t have to seek advice or permission from shareholders, directors, or partners. You’re able to make decisions on your own, act on them instantly and remain flexible and responsive to the needs of your customers.
As a sole trader, you don’t have partners or shareholders to pay or share profits with, and as such enjoy sole control of the business profits. You can draw from your profits at any time and build the business however you see fit. As long as you declare those deductions on your tax return, you have the freedom to manage your income as you wish, without needing to produce dividend vouchers or pay yourself a salary through a payroll system. All post-tax profits are yours to do with as you please.
If you’re operating a limited company, your accounts, along with details about the company’s directors are made publicly accessible through the Companies House website.
The same isn’t true for sole traders, as they are protected by HMRC’s taxpayer confidentiality rules. Your financial and personal data are kept private.
In addition to having more privacy, this also provides a competitive advantage, as it makes it difficult for competitors to gather information about your business.
However, this doesn’t mean that sole traders are completely anonymous. Remember that you’ll need to put some information out into the public domain in order to market your business successfully.
The Disadvantages of Being a Sole Trader
Although the many advantages of being a sole trader are undoubtedly why it is such a popular business choice, you need to be aware of the potential drawbacks:
On one hand, having full control of your business is a big advantage of being a sole trader. On the other hand, it means that you alone are responsible and accountable for everything.
The risks associated with being a sole trader can be high, and the biggest downside comes in the form of unlimited liability. You are personally liable for any business debts. If the business runs into financial difficulties, your personal assets could be at risk.
This is because, in the eyes of the law, there is no difference between the person running the business and the business itself. When it comes to recouping money owed by a business, a sole trader is liable to foot the bill. The sole trader is liable for all debts that the business acquires.
You are also personally responsible for any of your business’ bills, and personally responsible for keeping accurate records of your business’ sales and spending, including filing a self-assessment tax form every year. Sole traders carry the weight of a lot of responsibility on their shoulders.
Some safeguards are available in the form of insurance, such as unlimited liability coverage or long-term illness coverage. The right insurance product can be a good way of reducing your risks as a sole trader.
Whilst it’s possible to secure a level of protection with professional indemnity insurance and payment protection insurance, keep in mind that liability for your sole-trader business ultimately lies with you.
Fewer Options for Raising Finance
As a sole trader, your options for raising money to finance the business are somewhat limited. Limited companies have greater borrowing power as lenders are warier of sole traders due to the unlimited liability aspect and, in some cases, because of the private nature of these businesses. Generally speaking, banks and big businesses are generally more cautious about doing business with sole traders.
As a result, when sole traders do secure finance, the amount you’re able to borrow might be lower than a limited company and the rates not quite as favourable.
Limited companies can also raise capital by selling shares. This is not an option for sole traders, who have to rely on their personal resources to raise capital. If the sole trader runs out of money, the options are limited.
Unfortunately, some clients will prefer to deal with a limited company because sole traders might be perceived as a greater risk. This can result in you losing business simply because you set up your business as a sole trader.
However, plenty of clients prefers to work with a sole trader because they value dealing with a person (and the same person each time) who is completely invested in doing the best job.
It is worth considering who your clients will be before deciding on your operating structure. It is prudent to do some research on your market and potential customer base to see if you can work as a sole trader or whether you’ll need to form a limited company.
A sole trader business comes with a wealth of advantages. You can set your own hours and run your business however works best with your schedule. You’re the one who gets to make all the big business decisions. Since you’re the owner of the business, all profits that you make belong to you.
While there are several advantages to being a sole trader, it comes with some disadvantages as well. You have full liability if things go wrong.
It’s crucial to weigh your options when deciding on a business structure. Make sure you choose the one that suits you and your business best.
For independent advice to help you evaluate if becoming a sole trader is the right step for you, please get in touch to schedule a free 30-minute consultation.