Starting a business can be a daunting task. Are you self employed in the UK? Do you want to say good-bye to your desk job this year and start working for yourself? Setting up a company as a sole trader could be the next step you need to take.
There are currently 3.5 million sole traders operating in the UK. It's a popular business structure for people working as tradesmen or freelancers who offer a service like photography, writing, or decorating.
Sole traders can enjoy the freedom that having a nine-to-five job working for someone else simply can't provide. However, there are some things you need to know before deciding how to run your business.
In this article, we'll discuss all the advantages and disadvantages of setting up a business as a sole trader, to help you decide if it's the right business structure for you.
A sole trader is a business structure that refers to a self-employed person who owns and runs their business as an individual.
As a sole trader, you are the business. You have full control over your business, its profits (after tax), and its assets. Moreover, when operating as a sole trader, you're legally responsible for all aspects of decision-making within your business.
This business structure provides self-employed people with simplicity, flexibility, and a number of advantages (and disadvantages!) It's used by many businesses in the UK but is most popular among freelancers and tradesmen who provide services to individuals and companies.
Typically, you'll find writers, designers, plumbers, decorators among the types of self-employed professions. That being said, you can find people from all walks of life working as sole traders.
For an in-depth look at being a sole trader, we recommend you read our What is a sole trader guide.
The main difference is in the liability attributed to the owners in each business structure. Sole traders have unlimited liability, as the business is not a separate legal entity to its owner. This means the owner is personally liable if the firm fails or incurs large debts. On the other hand, limited companies offer limited liability as the business is a separate legal entity from the owner. This way, debts or business failures do not fall on one person but are divided among the shareholders to the extent of the value of their shares.
For a full comparison read our sole trader vs limited company guide.
The paperwork and accounting required for a sole trader business structure are fairly simple, so it's easy to get started in a matter of days. Incorporating a limited company is often more difficult and takes more time, as you're required to register with Companies House.
Sole traders are completely in charge of their business. This means they make all the decisions and keep all the profit. However, it can be more difficult to raise funds as sole traders are typically less trusted than limited companies, as there's only one person involved. Limited companies often have directors who run the business, or shareholders who invest money into the business. Profits are shared among those involved in the business and decisions are made together.
As a sole trader business, you're in charge of your finances and accounting. It's up to you to ensure your yearly taxes are paid correctly and on time. As such, sole traders are required to submit a self-assessment tax return form at the end of each tax year. To submit the self-assessment form, you'll need to keep track of all your business information and income, with invoices and bank statements, to present to HMRC at the end of the year. Failure to declare your taxes may result in large fines.
Offering a service as a sole trader has both advantages and disadvantages. In the next section, we'll help you to understand how these might affect you.
Sole Trader Business Advantages
Here are the main advantages sole traders may benefit from:
Everyone dreams of working for themself one day. Not having to answer to anyone, working on your own schedule, no tedious business meetings to attend! Working for yourself is great! As a self-employed person, you set your own work rules.
As you work for yourself, you can choose to open and shut up shop when you please. This gives you the freedom to take on and reject new projects based on your schedule. You can also easily implement change without having to consult with shareholders or other people. Essentially, the business is yours to do with as you please.
Sole traders retain all of their profit. It doesn't have to be shared among shareholders or left within the business. Most sole traders choose to work alone, which allows them to keep costs to a minimum and maximize profits. In addition to profit retention, a sole trader may also retain personal ownership of business assets.
Sure, setting up limited companies isn't as difficult as it once how. However, setting up as a sole trader is the more efficient business structure to set up.
You won't need to register your company with Companies House or go through the hassle of collecting the documents required to do so. Instead, you'll just need to inform HMRC that you're self-employed and operating your business as a sole trader.
Although it's simple enough to start and register a company independently, most people opt for a limited company formation agent to take care of everything for them. Legal details, documents, and bureaucracy can get complicated; sometimes it's easier to leave it to the professionals!
Of course, the agent isn't going to do it for free, so this can add to the costs involved in starting your small business. As a sole trader, there are no fees to pay to Companies House, and you're much less likely to need much capital getting started.
Limited companies are published on the Companies House website. Their published accounts aren't kept private. One of the main advantages of being a sole trader is that your accounting and personal details kept private, so you can enjoy maximum privacy.
As a sole trader, you're your own boss. You retain full control over your business, how you operate it, and any change you decide to implement. There's no need to consult with directors or shareholders, so you can develop your business in the way you see fit.
Despite the many advantages, there are also some downsides to being a sole trader.
A limited company is typically considered to be more tax-efficient than the sole trader structure. As a sole trader, all of your profits are subject to income tax. A limited company has more flexibility to work around taxes and maximise their earnings. A sole trader, however, has less flexibility within the tax system.
Sole traders have tax free personal income allowance of up to £12,500, after that they'll be required to pay a basic income tax rate of 20%. If the amount earned exceeds £50,001, that rate jumps to 40%. You can read more about tax rates for sole traders here.
When you run a sole trader business, the amount of work you have is dependent on your availability and hours. For instance, if you've already undertaken a project but get asked to do another in the meantime, you can't send someone else out to do the job. This can place limits on the number of jobs you can complete and thus your income. Moreover, if you're sick and unable to work, there's no sick pay to cover you.
As the owner of your sole trader business, you make all the decisions. Although this can be a good thing, making all the decisions can take its toll. Decision-making during difficult times may increase stress levels and put increased pressure on sole traders. In turn, this may result in poor decision-making.
So, is it worth it to start a small business as a sole trader? When you're just starting out, setting up as a sole trader is often the easiest choice. Despite the unlimited liability, you also have the freedom to run your business in the way you want. You're in full control, you choose your hours, and you keep all the profits. Essentially, all the important decision-making is in your hands.
One of the most attractive aspects of being a sole trader is how easy it is to set up. There's less paperwork involved than is required when you set up as a limited company, and all you need to do is complete a self-assessment tax return form each year.
There are many benefits of being a sole trader as a small business, however, once your business reaches a certain level of success you may want to consider transitioning to a limited company fro the professionalism and limited liability it offers.