Setting up as a sole trader is the most popular way of starting a business in the UK for good reason – its the simplest and there is very little to stop you from just getting going. For many that dream of owning their own business or breaking free of the conventional 9-5, becoming a sole trader is a great option that has plenty of advantages vs employment or other forms of business structure. However, before diving in, its a good to understand the advantages of being a sole trader along with it drawbacks vs the advantages of being a limited company. Every situation is different and each will require some careful consideration of which is best suited to you.
Advantages of being a sole trader
You control the business
Sounds obvious, right? As a sole trader you’re in complete control of the business; the decisions, how much you work, how much you charge and its future direction. You are ‘your own boss’, answering to no-one other than your customers and occasionally the tax man (more on that later). The distinct lack of other directors or shareholders can be very appealing for those who do not want to compromise – what you say, goes.
Flexibility
As you are your own boss, you can work when you want and how you want. This kind of flexibility might be attractive for those juggling other responsibilities and commitments such as childcare. Whether you want to work from home, the local coffee shop or cut down your commuting, being a sole trader can give you the flexibility to work around your lifestyle.
Quick and simple to get started
Setting up as a sole trader is the quickest and simplest way of starting a business as you don’t need to jump through a lot of legal hoops or register the company with Companies House. You can trade as almost any name you wish as long as it doesn’t infringe copyright or trademarks of others. Most people who operate as a sole trader have businesses that have “trading as” after their company name. You will still need to inform HMRC that you’re self-employed and operating your business as a sole trader for tax purposes.
Low setup costs
You don’t need to register your company with Companies House and therefore eliminate the registration fees (although registering a limited company can be done very cheaply). Depending on what your business is, you might not need much in the way of finances to get underway but some startup costs (equipment, supplies, etc) may be unavoidable.
Simplified Accounting and Form Filling
No-one setting up a business relishes the thought of doing their accounts or taxes. If this is something that might put you off setting up a business, fear not. Filing accounts for a sole trader is far easier than it is for a limited company as you don’t need to prepare and submit Annual Accounts or a Corporation Tax Return every year. These can be fairly complex and require a qualified accountant to navigate so you will be pleased to know you only need to submit an annual personal Self-Assessment Tax Return which will include details of profits from the trading you’ve undertaken as a sole trader. For this, you will need to keep a record of your income and expenses (keep all of those receipts somewhere safe). It is, however, worth noting that if your turnover is above the £85,000 threshold, you may have to register for VAT also.
You Keep a Large Degree of Privacy
This won’t be top of everyone’s wish list but being a sole trader does allow you to keep a number personal and financial details private. Although as a sole trader you will still need to submit your tax return, it doesn’t become a public record. Equally, your personal details remain private. If your company is registered with Companies House, your annual accounts are published for all to see (if they choose to look) and the details of company directors such as name, date of birth, nationality, country of residence, occupation and correspondence address (which may be your home address if you don’t have a business address) are visible in the public records which may be disconcerting for some.
All of the profits are yours
Another no-brainer. You don’t need to share any of the earnings of the business with anyone or leave profits in the business. It’s yours, all of it (minus appropriate taxes of course). As well as the profits, you also have personal ownership of any equipment used in the business, so that shiny new laptop you need to work on would belong to you and not the business. It’s worth noting that with other business structures (such as a limited company) it would be the business that owns the equipment and not you personally.
You can claim some tax back on some expenses
Although you still have to pay taxes (sorry, it’s the only other thing as certain as death), there is something very satisfying about being able to claim some of it back. You will probably need to buy equipment such as a computer, tools and machinery, vehicles or office furniture in order to run your business and you may be able to claim capital allowances on these, which is effectively a tax relief. There are other expenses that may be tax deductible; HMRC rules can be complex and are often based on concepts such as the ‘fairness’ and ‘reasonableness’ of expenses claimed. You may need to consult a tax specialist, but it is good to know that expenses can be used to offset taxes, leaving you with more money in your pocket.
You can dip your toes in
For many the prospect of leaving the 9-5 to go it alone is unrealistic, especially if you are just starting out. Many will look to work on the side while also remaining employed elsewhere to retain the security of a salary. Dipping your toes into business as a sole trader allows you to build up the business to a point where you can leave your day job or simply have a nice side income to supplement your salary. You may start out as a sole trader but there is nothing stopping you forming a limited company later down the road as the size and nature of your business can change quickly. As long as someone hasn’t already registered your company name with Companies House you should just be able to use your existing company name with an ‘Ltd’ added at the end.
You can still employ others
Although you run the business on your own, you can still employ others to work for you. You might do this in order to free up your time to grow the business or to simply do some of the things you don’t have expertise in. Either way, if you do employ people, you will need to collect income tax and National Insurance contributions (NICs) from them and pay these to HMRC. You’ll need to operate a PAYE (Pay As You Earn) payroll scheme for this purpose, so while having others do the work for you may be appealing, having to manage them and deal with the admin of their pay might not be.
Disadvantages of being a sole trader
While there are many advantages of being a sole trader, there are also some drawbacks that you may wish to consider on balance against other business structures, such as a limited company.
Personal financial risk
In becoming a sole trader, both you and your business are seen as one. Whilst this can be a beautiful union, like any marriage you share the financial risk. Its debts are your debts. Unfortunately as a sole trader you have unlimited liability for your business, meaning if your business builds up debts that cannot be repaid from the business income then your personal finances (savings and investments, etc) and assets (property including your home, cars, etc) could be taken as repayment. ‘Unlimited’ can be great – unlimited refills, unlimited minutes and texts, unlimited usage; but not in this case. As a sole trader there is no protection for your personal finances or assets. With the ‘unlimited’ weighing heavily against you, you could find yourself losing your home as well as facing bankruptcy.
Many types of business will be able to manage certain levels of debt, but if you think this may be too big a risk for the type of business you want to run then you may want to consider becoming a limited company. A limited company sets you and the business apart as separate entities and therefore the liability is on the business and not your personally. If the business finances go belly up then your personal finances will be safe (apart from any you may have put into the business that is).
Tax system may not work as well for you
No-one likes tax and we’d all prefer to pay less of it but being a sole trader may mean you pay more than other business structures. There isn’t one hard and fast rule as tax can be complicated and is different in different situations but there are generally less opportunities to trim your tax payments as a sole trader than as an owner of a limited company. As a sole trader, if you are lucky enough to make good profits, these are subject to income tax in the year in which they are made. Sole traders have the same tax status as individuals, with a tax-free personal allowance of £12,500 for the 2020/2021 period. You start paying tax on income above this figure, which stands at 20% between £12,500 and £37,500, 40% for income between £37,501 and £150,000 and 45% for anything above £150,000.
As a limited company you can draw dividends from the company which can be taxed at a lower rate and profits can also be left in the business and drawn as income in a later year when your income (and potentially your tax rate) might be lower.
Harder to take breaks
One of the great benefits of being a sole trader is working when you want but ultimately we all have to make ends meet. For many, the pursuit of happiness can mean long working hours when everything falls on you and your capacity to work. For the majority of sole traders who do not employ others it can be difficult to take holidays or even sick leave. The business can take an increasing amount of your time and energy, tipping your work/life balance more towards the work side of the scales, which can be too much for some.
You are the decision maker
Whilst having full control of your business and being able to do what you please with the business are advantages of being a sole trader, they can also be a disadvantage. For many it is a new concept and full of pressures to make the business work, which can be a daunting prospect. Decisions (both good and bad ones) rest on your shoulders and can make or break your business.
You have to wear many hats
Chances are you have a specialism in your chosen field and while you are good at one thing (or a few things if you are lucky), there will be many other aspects of running a business you won’t be so familiar with. Do you understand accounting? Do you know how to market your business? Do you have the gift of the gab when it comes to selling? Many work better sharing responsibility with others and making use of their different skills but crucially, as a sole trader you need to be good at what you do and be good at sales and marketing. Where there are things you can’t do, you need to consider buying in that expertise and knowledge, which of course begins to add cost.
You are less attractive to some clients
In the eyes of some clients, sole traders lack the shine of a limited company. That’s not to say they are any less capable, but there can be a perceived prestige that a limited company carries. Sole traders can be viewed as small, one man band types that are less professional than a limited company. You can hide a lot more behind the facade of a limited company, but it is plainly obvious that a sole trader is likely to be just you at the helm. For this reason, sole traders may struggle to attract bigger clients – some clients will simply prefer to deal with a limited company. Whilst it doesn’t seem fair, you could lose out on business purely through setting your business up as a sole trader. In some industries there’s effectively little option but to set up as a limited company. Similarly suppliers, in some cases may not supply goods or services to a sole trader, or perhaps will do so on worse terms compared with a limited company.
Difficult to secure funding
Part of the beauty of being a sole trader is that you can set up with little to no finances and have a go. It’s worth noting that if you think you will require lending to set up and operate your business, you may want to consider forming a limited company as sole traders can be seen as riskier than other business structures. Banks may simply be unwilling to lend large sums to sole traders and where they do give loans, the terms offered may not be on par with those offered to a limited company. As a sole trader you will likely find that most other forms of long-term finance will not be available as unlike a company, they cannot issue shares or other securities in exchange for investment. Some government schemes also may not be available to sole traders.
Reverse economies of scale
Put simply, as a sole trader you may not be able to buy in bulk in order to gain cheaper prices. This may be due to the finances required to purchase in bulk, the lower customer base or unfavorable terms offered by suppliers. This lack of buying power may mean that due to higher costs, you need to pass on higher prices to your customers (which may make you more expensive than competitors) or that you have to absorb these costs (making you less profit).
No-one to pick up the pieces
This is unlikely to be a common issue but it is worth consideration. As a sole trader, what happens when you retire or if you die? The life of the company is effectively limited to that of your own. Hopefully you live long enough to retire but in the event that you don’t, those left behind might find it difficult to pick up the pieces of the business to either continue or sell it on. As a sole trader the business is effectively you – in death that leaves little to really sell on. Additionally (and slightly less morbid), if you are ill or have an accident that means you cannot work, as a sole trader you may not be able to compete for new business or indeed fulfill existing work commitments. What do you do if you are unable to work and make an income?
There is no definitive right or wrong answer as to whether you should set up as a sole trader. It will heavily depend on your individual circumstances and for many the advantages of being a sole trader will outweigh the potential benefits of setting up a limited company. Like anything, there are also disadvantages to operating as a sole trader, which you should also give some serious consideration.