Depending on their business structure, tradespeople like plumbers and tilers often prefer setting up as Sole Traders. This is because they primarily work alone, and there is little to no need to create a Limited Company unless the business expands to taking on franchisees or employees.
Sole Traders aren’t just limited to those in trades though. Other business owners including examples like marketing agencies prefer setting up as Sole Traders because of the ease of set up and the reduced amounts of paperwork required when compared to setting up a Limited Company.
So if you’re a business owner also facing the division as to whether to set up as a Limited Company or a Sole Trader, we’ve compiled a list of advantages and disadvantages to help you decide the best business structure for you.
What is a sole trader?
Firstly, the definition of a sole trader is an individual that runs their own business. As they are often the only employee – hence, sole – they can also be referred to as simply self-employed.
The structure is particularly preferable to freelancers who work alone, or tradespeople like independent electricians.
A sole trader business does not, however, possess a separate legal identity from that of its owner. This means that the business owner often becomes the face of the business, for example, Pete’s Plumbing.
Sole trader advantages
Sole traders have many advantages which are what makes it such a popular business structure for small business owners.
Here we’ve listed all the advantages of setting up as a sole trader:
Being your own boss
This is the primary advantage for many business owners, whether setting up as limited companies or not. However for sole traders, because there are often no investment opportunities or co-founders, they become the person with significant control.
Ultimately that means that sole traders can work the hours they wish, when they wish, as well as running the business exactly how they wish and in which direction they wish.
The freedom with decision making and structure that sole trader businesses offer is often what entices sole traders to set up as such, especially if they feel they are best when working autonomously.
Receive 100% of the profits
An incredibly attractive benefit of being a sole trader is that sole traders are allowed to keep all the profits they make after tax.
In a Limited Company or joint partnership structure, these profits would have to be split or paid to employees, investors or shareholders.
If the business does well, it can be a very profitable business structure.
Easy to set up
Setting up as a sole trader is vastly more straightforward than the set up of a limited company.
To set up as a sole trader, sole traders must inform HMRC and register as self-employed if they have earned more than £1,000 from 6th of April to the 5th of April in the following year. Registration can be done online or through the post.
Low start-up costs
There is no cost to registering with HMRC, so the actual set up of the sole tradership does not incur any start-up costs. Whereas limited companies must pay to incorporate their company with Companies House.
Low, minimal or no start-up costs can be another attractive proposition for sole traders, especially if they are able to complete their work with already existing equipment or they do not have much capital, to begin with.
At MachFast, we help sole traders reduce their startup costs, even more, when they register on our free app!
When Limited Companies register with Companies House their information goes on the public record. This can include their residential address, name and any shareholders and directors, vastly reducing the privacy of those involved in the business.
However, sole traders do not register with Companies House meaning that their information can be kept private. Whilst some sole traders will naturally become the face of their business as they market it, they are still opting to censor which information they share. This is a lot different than having information easily accessible to the public.
Changing the business structure is easier
Sole traders may start alone, but if their business does well it may need to expand. This could include buying premises, taking on staff, or opening itself up to investment opportunities.
Alternatively, if the business sees a significant increase in its income it may work out more tax-efficient to then switch to a limited company structure.
Thankfully the process of doing this as a sole trader is easy. All sole traders need to do is:
- Register as a Limited Company
- Inform HMRC of their decision to stop sole tradership
- Transfer their sole trader business to the limited company
- Set up a business bank account
- Notify any necessary persons, such as clients or stakeholders
Sole Trader disadvantages
Just like anything in business, where there are advantages, there are disadvantages. Here are the disadvantages of being a sole trader:
Sole trader business structures mean that the business owner and the business are seen as one entity.
Therefore sole traders possess unlimited liability for their businesses. If the business suffers consequences or falls into debt, these then become the sole responsibility of the business owner.
As there is no protection of a business owner’s personal assets and finances, sole traders are viewed as much more financially risky as one wrong move could harm the business as well as its owner.
Less tax efficient
Sole traders are offered less flexibility to work around taxes in order to maximise their profits than limited companies are.
Sole traders are issued a tax-free personal allowance of £12,500, but then they must pay an additional tax rate on any further income received.
The bands for the tax rate payments in 2020/21 are:
- 20% on income between £12,501 and £50,00
- 40% on income ranging from £50,001 to £150,000
- 45% on income that exceeds £150,000.
So whilst sole traders may receive more profits, they may also pay more taxes on those profits.
Harder to take breaks
As sole traders work alone, taking breaks can be a lot harder to justify and more costly to both the business and the owner as there is nobody to manage the business while they are away.
However, sole traders must look past this and take breaks by properly planning and scheduling time off, and by informing clients in advance.
Being the sole decision-maker
Most sole traders become sole traders because they prefer to work alone. Whilst they might have all the say-so, sometimes we all need someone to bounce ideas off of or run things past.
Sole traders do not have this and sometimes having complete control can become overwhelming and pressurised. It can be harder to make decisions without trusted external input or advice.
Plus, any bad decisions fall entirely to the responsibility of the business owner which can sometimes lead to increased levels of stress, impacting on mental wellbeing.
Potentially less attractive to clients
Limited companies can enhance their business’s image by putting LTD after their name. To many customers or clients, this looks more credible and therefore trustworthy.
Depending on the industry the sole trader is entering into, sometimes not having the stamp of a Limited Company can dissuade customers who may feel uncertain of using the business.
As a sole trader, it is more difficult to create an image of a big business when most of your clientele will know you work alone.
Further Reading: What are the Top 5 Limited Company Benefits?
Increased difficulty when securing funding
Due to the unlimited liability and less professional image when compared to a Limited Company, sometimes sole traders are viewed as riskier investment ventures than other business structures.
Securing funding from financial institutions like banks can be infinitely more difficult, as can independently raising funds for the business. Because owner and business are intertwined, many are under the misconception that the business owner will profit from the funds without actually enhancing the business.
Therefore if at any point the business would require funding, business owners must weigh up their potential investment financial options. This could also lead to the decision to change the business structure in the future.
It’s no surprise that sole trader business structures are popular choices for individual entrepreneurs who want to keep their costs low and their paperwork minimal.
Whilst there are disadvantages to sole tradership like unlimited liability and tax inefficiencies, business owners must ultimately decide what business structure is best going to suit them and their business structure.
Whichever business structure entrepreneurs choose, MachFast offers a quick, easy and free way to register new businesses. Just check out our app!
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