It’s a growing trend for people to aspire to work for themselves and be their own boss especially in a post-covid age of remote working. In fact, in the UK today, around 4.25 million people have taken this path, hoping to find greater satisfaction and more flexibility in their professional lives. So, what are the advantages and disadvantages of being a sole trader?
The first big decision after taking the plunge into the world of self-employment is your business structure and there are two conventional options to choose from. The simplest option is becoming a sole trader, and another is setting up a limited company. Both have their own advantages and drawbacks. To help determine which legal structure is best for you and your business, read on for a cohesive list of the pros and cons.
But first, what is a sole trader?
Put simply as possible, a sole trader is the sole’ owner of a company, meaning that the owner and their business are merged into one financial and legal entity. So, when you’re both self-employed and the exclusive owner of a company you’re considered a sole trader (also known as a sole proprietor).
In this case, it’s one individual’s responsibility to handle company decisions and liabilities and distribute all the profits which
And what is a limited company?
In contrast, the owner(s) of a limited company remain separate legal entities. This means that you and other directors are completely separate from the business finances, debt and legal claims are all tied with the company, not you as an owner.
Limited companies function around shareholders who have a vested interest in the company. They each receive a share of the declared profits dependent on the amount and type of shares they own.
What are the advantages of being a sole trader?
Low costs
Sole traders generally have a low start-up cost as only a small amount of capital is needed. In fact, registering with HMRC is free, so no costs are incurred for completing the paperwork.
Control
It’s easier for sole traders to retain full control of their business. The proprietor can run the company without worrying about the interference of other businesses, intermediaries or individuals, allowing them to concentrate on their customers’ needs and build powerful client relationships. If you’re currently employed and want to go self-employed, your current employer might even become a client in time.
Additionally, if your business resides within the creative sector, having full creative control can also be very freeing and allow you to pursue your objectives and ideas that may not be considered strictly commercial.’
Less red tape and paperwork
Compared with limited companies, sole traders have much less paperwork to wade through and when you register as self-employed the whole set-up process is much simpler. Due to this, legal fees and accountancy services are generally lower.
Privacy
A sole trader can keep their private information and business details away from public records, whereas anyone can inspect a limited company’s accounts if they wish to do so. As a sole trader, you have the ability to be as transparent as you want and keep your financial details completely private.
Easy to change your mind
People making the leap from employment to self-employment often choose to become sole traders initially. But moving to become a limited company is always possible at a later date. This is perfect for business owners who want to start up small and gradually grow as they gain financial assets and perceived legitimacy. In this way, it might also be more tax-efficient to switch to the limited company model at this later point.
However, it’s important to note that going in the opposite direction is a little more difficult, with a more formal process involved in closing the limited company.
And the sole trader disadvantages?
Liability
By law, sole traders are not seen as separate entities from their businesses therefore, they have unlimited liability. This means that the business’ debts and liabilities are yours, and you are liable. Taking out insurance could minimise this risk in some, but not all instances, so it’s important to consider whether you’re willing to risk this prospect. When a business can’t pay its creditors, personal assets may be seized to meet its demands, including a house or car.
Tax
As mentioned above, sole trader businesses have unlimited liability, unlike limited companies so it’s essential you keep up with your paperwork and file your taxes carefully. One way of streamlining this is making tax digital which will reduce paper records and increase accuracy.
Sole traders are required to properly account for all sales, expenses and profits to meet National Insurance and income tax liabilities which eats into valuable business hours, whereas the employee of a limited company may not have to deal with this personally, depending on their role.
However, sole traders benefit from keeping all profits on tax after profits that is, until they exceed their tax-free personal allowance of £12,570 and have to pay tax on further earnings according to the relevant threshold. Sole traders may function less tax efficiently than directors of limited companies, depending on how those directors pay themselves and the mixture of salary and dividends.
Benefits
Likewise, as a sole trader, there are no benefits such as paid holidays, sick pay, or employer pension contributions that employees of a limited company might enjoy.
Finances
Sole traders may find it difficult to raise funds for their business and may therefore struggle to grow their business. Banks tend to be unwilling to lend large sums to sole traders due to the lack of transparency and perceived legitimacy and risk.
Decision-making
With freedom comes responsibility. All the decisions are made by you as a sole trader, so the success or failure of your business depends on you alone and if you’re just starting out there’s so much to learn.
Work-Life balance
When you’re personally invested in the company, it can be difficult to set boundaries and switch off your work headspace.’ So, if you’re worried about burnout and the toll the entrepreneurial lifestyle may have on your life you should consider how best to manage this.
Is being a sole trader best for you?
It’s helpful to note that the model of your business need not be set in stone. Don’t forget that you can transition from one structure to the other in the future with enough careful planning. With this in mind, however, the decision remains a big one and no one can make it for you.
Whether you should start up your business as a sole trader or a limited company really depends on your personal situation and working preferences. The advantages of being a sole trader afford you control, flexibility and privacy, whereas the disadvantages of becoming one relate to liability, financial risk and workload. These pros and cons should be the key considerations at the front of your mind as they will shape how your business start-up will grow and evolve.
If you’re an entrepreneurial person willing to invest the time and effort into your business the sole trader model could be for you. And if you’re leaning toward going limited’, we have a helpful guide to walk you through the pros and cons of setting up your business as a limited company.
Final thoughts
The most important takeaway is that you consider all of your options. Weigh up your personal sole trader advantages and disadvantages, review your priorities and take the time to thoroughly research your choices and their implications. Only then should you make your decision.
Business advice you can rely on from UWM
Are you starting your own business? UWM’s Business Start-Up service is the perfect support system for small start-ups with big ambitions. Get in touch with our team to find out more. Call 0113 231 0202 or complete an online enquiry form and a member of our team will be in touch very soon to discuss your requirements.
