Advantages and Disadvantages of Being a Sole Trader
When working for yourself, one of the biggest decisions you will have to make is to decide the best way in which you operate. Are you going to become a sole trader or are you going to create a limited company?
It is a big question, which is why we have broken down some of the advantages and disadvantages of being a sole trader so you can make an informed decision on what is best for you and your business.
What is a sole trader?
Before we start, it is important to understand what a sole trader is and why it is an appealing option for many people starting out on their business journey.
A sole trader is someone who is self-employed and running their own business as an individual rather than a corporation. This means they are responsible for all aspects of the business from a legal and financial perspective.
The advantages of being a sole trader
Immediate start – As your business isn’t a legal entity on its own, there is no formal registration process in the same way as there is for a limited company. For example, you do not have to worry about registering your business with Companies House. This means you don’t have to wait for approval before you start working and can begin as soon as you are ready without worrying about additional paperwork.
You are your own boss – The main perk of being a sole trader is that you get to be your own boss. This means you have complete control over the direction of your business and can run it in the way you deem appropriate. You call the shots, make all the decisions and have complete ownership of the business’s trajectory.
If you decided to conduct your business under a different business structure like a joint partnership, you would have to confer with partners and colleagues before coming to an agreement on how the business is run and how to deal with certain situations.
Low start-up costs – The main thing you need to do as a sole trader is to declare yourself as a sole trader to the HMRC (HM Revenue and Customs). This is to ensure they are aware of your situation and that you can make the correct tax payments when the time comes. All that’s involved is filling out a self-assessment tax return form, which is completely free and will considerably reduce your start-up costs.
If you were a limited company, however, you would have to pay a fee of £12 online or £40 by post in the first year. There is an annual confirmation fee of £13 if done online or £40 if paid via post.
You can change business structures – Just because you opt to become a sole trader at the start of your business journey does not mean you have to remain that way. The advantage of being a sole trader means you can easily change your business structure as you expand and grow. This is natural and allows you to keep an open mind to future opportunities.
Complete privacy – Limited companies who have to register on the Companies House website have to declare all their financial information as well as details about their directors and shareholders. Nothing is kept out of the public eye. As a sole trader, you do not have to register with Companies House, allowing you to keep your business’s financials private and for your eyes only.
You keep all the profits – Another advantage of operating as a sole trader is that, after you pay the required tax, all the remaining revenue that the business generates will belong to you and you alone. This is not the case under other business structures.
If you set up a joint partnership, for example, you would obviously have to share the profits with your partner. In the same vein, if you were a limited company, the shares would have to be divvied up between investors and shareholders.
With all the good that comes from being a sole trader, there are also some elements of being a sole trader that can be challenging.
The disadvantages of being a sole trader
Unlimited liability – Unlimited liability is a business term that makes the business owner responsible for paying any debts or financial obligations incurred by the business.. This of course is one of the key risks of being a sole trader. The debts are not capped, which means the sole trader may be left with no option but to delve into their personal assets in order to pay off the debt.
If you register as a limited company, you instead have limited liability. Limited liability prevents individuals from personally being responsible for business debts. It instead puts the responsibility on the business itself and is capped to what the business can pay. This means the business owners’ personal assets are protected.
More difficult to secure funding – Every business needs capital, but the unlimited liability attached to sole traders makes them a risky option for banks to invest in. That’s why most sole traders will have to rely on their savings or loans from family and friends in order to get up and running, but there will come a time when that isn’t enough.
As the business grows, you will naturally require more capital, which means looking to a bank for a loan if your profits aren’t yet high enough to fund the expansion. If you fail to secure a loan from a bank, you may have to look into an alternative financing option, such as crowdfunding.
Being the sole decision-maker – While there is definitely beauty in being the one calling the shots, this singular responsibility may not be for everyone. It can be quite daunting and adds increased pressure to an already high-pressure situation. Mistakes and problems are part of the course and can be particularly stressful if the success of your business rests solely on the decisions of you and you alone.
Harder to attract clients – There is a certain element of professionalism that is ascribed to limited companies. They are seen as more polished, armed with experience and a team behind them. While sole traders can be just as experienced as a limited company, the perception people have of sole traders may make your business appear less reliable or equipped to investors and clients alike.
It might not be tax efficient – As a sole trader, the rules around tax are more rigid than they are for a limited company. This makes it harder for you to maximise the income you make. For example, as a sole trader, the profit you make is subject to income tax from the financial year in which you earned it. This means, unlike a limited company, you cannot leave the profits in your business account to be used in the following year.
While being a sole trader is seen as the biggest risk, neither route – including joint partnerships or operating as a limited company – is easy.
Each one comes with its own unique set of situations. The key is to find out which situations suit you and the lifestyle you wish to have.
Are you a sole trader looking to grow? Get in touch today
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So, what are you waiting for? Let us answer your calls today!