One of the first decisions that you’re likely to make when going self-employed is choosing the way in which you provide your services to clients. Will you form a limited company? Band together with someone else and create a partnership? Or might you join the 3.5m other people working as sole traders today in the UK? If you’re interested in becoming a sole trader, look no further. To help you make up your mind, we’ve weighed up the advantages and disadvantages of working as a sole trader below.
Firstly, what is a sole trader?
Sole traders are self-employed people who own their entire business and run it as an individual. In other words, there’s no legal distinction between you and your business, which is why it’s often said that sole traders are their business. To learn more about what it means to be a sole trader, view our sole trader business guide.
The advantages of being a sole trader
From a fast and simple start up process to relatively few reporting responsibilities, let’s take a look at the advantages of being a sole trader:
1. Get started immediately
As a sole trader, you don’t need to register your business with Companies House. This is because it isn’t a separate legal entity, in the way that a limited company is. As a result, a benefit of working as a sole trader is you can start working right away.
2. Simple registration
The only thing sole traders are legally required to do after having started working this way, is register as self-employed for tax purposes. This is effectively you telling HMRC to expect your Income Tax via the Self-Assessment Tax Return. Registering is a simple process and in many cases doesn’t necessarily need to be done the moment you go self-employed. Find out how to register as a sole trader.
3. Fewer fixed overheads
As a sole trader, your start up costs are minimal – if anything at all. Better still, with few annual accounting obligations, you can keep your fixed overheads low, which is important for those just starting out.
4. Complete control
As the sole owner of your business, you have full control over it. Without any shareholders or directors in the equation, you’re free to make your own decisions and run your business exactly how you want.
5. Financially rewarding
Given there are no other owners of the business to share profits with, everything a sole trader makes after tax and expenses is theirs to keep.
6. Fewer tax responsibilities
Your tax responsibilities are relatively straightforward as a sole trader. There’s no Corporation Tax to pay or annual accounts to submit to Companies House because your business isn’t incorporated. All sole traders need to submit and pay is the Self-Assessment Tax Return annually and, if and when they become VAT-registered, file and pay this quarterly.
7. Less paperwork
You’ll encounter less paperwork when working as a sole trader than you would as a limited company director. Again, this is because your business isn’t a separate legal entity and so there are fewer filing requirements. So no need to file a confirmation statement or maintain statutory registers, which include details of individuals who have an interest in the business.
8. Organisational flexibility
A big advantage of being a sole trader is the flexibility it offers. If, further down the line, you want to go limited, the process is uncomplicated – much simpler than switching from running a limited company to being a sole trader, which involves dissolving your registered business.
9. Total privacy
Whereas a limited company’s annual accounts can be accessed on the Companies House website by anyone, a sole trader’s financial information is kept private. This means your finances aren’t available to the public, which many people prefer.
The disadvantages of being a sole trader
We’ll now drill down into some of the potential drawbacks and so-called disadvantages of being a sole trader:
1. Unlimited liability
Unlimited liability means you’re responsible personally for any debts and losses of the business, whether that’s outstanding tax, office rent or equipment costs. So if you run into financial difficulties, personal assets such as your house could be at risk.
2. Potential credibility issues
For whatever reason, a sole trader business doesn’t carry with it the perceived prestige of a limited company. Given this could affect the clients that you’re able to attract, it’s worth looking into the most common structure for successful freelancers or businesses that you would like to emulate before making your decision. If you intend to work through recruitment agencies, they may insist on limited company status. It is worth considering who your clients will be before making a decision on your operating structure.
3. Sole responsibility
On the one hand, having full control of your business is a big advantage of sole trader life. On the other, it means that you’re responsible and accountable for everything. That said, for many self-employed people this is exactly what they want. Those working through their own limited company often find themselves in this boat too, even if they have the opportunity to bring other people into the business as shareholders or directors.
4. Fewer tax planning opportunities
Sole traders have fewer tax planning opportunities. This is because the profit you make is subject to Income Tax in the financial year in which it’s earned. You can’t, for example, leave profits in your business and pay yourself these further down the line or in the next tax year as you might when running a limited company.
5. Barriers to finance
Generally speaking, lenders are more wary of sole traders because of the unlimited liability aspect and, in some cases, because of the private nature of these businesses. 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.
6. Sale limitations
Selling your business as a sole trader or having someone take it over when you retire isn’t as straightforward as it is for a limited company. Not being legally separate from its owner makes things slightly more complicated and you would need to organise a transferral of assets, over to the new owner.
Given many people who decide not to work as sole traders choose to set up a limited company instead, you might find it useful to see how these two business structures measure up against one another in our sole trader vs limited company guide. As you can see, there are plenty of reasons people work this way – the important thing is that your operating structure is right for you and your business. . To hear how SJD Accountancy can help you navigate your finances and manage your tax responsibilities as a sole trader, simply get in touch.