Sole Trader Advantages and Disadvantages

A sole trader is a one-man operation. It is a business structure in which one person runs and owns the entire company. Contrary to popular belief, being a sole trader doesn’t mean you’re not allowed to hire employees, but it does imply that you are solely responsible for all aspects of your business. As a sole trader, you are fully responsible for your company’s finances, including losses and payments, as well as keeping accurate records of your sales and expenses.

All of that may have sounded a little too much for one man, but being a sole trader has its benefits as well. In this article, you’ll discuss the advantages and disadvantages of being a sole trader.

What exactly is a Sole Trader?

A sole trader or sole proprietorship is a business structure in which one person runs and owns the whole operation. This business model can be employed by a wide range of businesses and is a common choice for business owners that provide services to individuals or other businesses. Freelance writers, consultants, graphic designers, plumbers, financial advisors, landscapers, and fitness instructors are among those who fall into this category.

As a sole trader, you enjoy both advantages and disadvantages. You are solely liable for all aspects of your business’s finances, including losses, debts, and maintaining correct records of your sales and spending.

However, keep in mind that the phrase relates to the business’s structure, not the number of people. While a sole trader is self-employed, this does not necessarily imply that they work on their own without the assistance of others.

Advantages and Disadvantages of Being a Sole Trader

It is fairly common for people beginning a small business to set up as a sole trader. This is due to the fact that it is by far the simplest and least expensive business form to establish. Because the sole trader form is inexpensive to establish, there are fewer legal and tax difficulties.
For those just starting out, being a sole trader might be very enticing. However, it is critical to consider both the advantages and disadvantages of functioning as a sole trader. 

Advantages Of Being a Sole Trader

When you start a business, one of the first things you do is choose a business structure. A sole trader is the simplest of all company formations to establish, and it has several advantages. Furthermore, if circumstances change, the company’s legal form is simple to amend.

#1. Easy to set up

You’ve just formed a single trader when you open your doors and start doing business. To register as a sole trader, you don’t need to fill out any paperwork with the federal or state governments. You may, however, be required to seek a business license or a certificate of occupancy, depending on local rules. If you run your business under a different name than your own, you may need to register your company’s name as a DBA (doing business as) name.

When naming your company, there are a few guidelines to follow:

• A sole trader’s name may not contain the words ‘limited,’ ‘Ltd,’ ‘limited liability partnership,’ ‘LLP,’ ‘public limited company,’ or ‘PLC.’
• Your proposed name should not be infringing on an existing trademark. Also, you should look into the UK Intellectual Property Office’s trademark register.
• Check to make sure your proposed name isn’t the same as an existing name. Check the availability of company names on Gov. uk using the company name availability checker tool.
• It must not be offensive or include sensitive words or expressions. Also, check out the Gov. uk resources for more information on sensitive words or names to avoid.

#2. As a sole trader, you have an advantage in terms of privacy over other types of businesses.

Since your business details are only known to HMRC, you have more privacy. This is not the case for incorporated businesses, as business details, such as your company accounts and confirmation statement, are available to the public once they are filed at Companies House.

#3. You have complete authority

As a sole trader, you have complete authority over the company and are not required to seek approval from a board of directors, stockholders, or anyone else. All of the hiring and firing, as well as all of the decisions, are handled by you. However, if being the single decision-maker is a hardship, an owner should think about it. If this is the case, forming a partnership would be a preferable option.

Although sole proprietorships have only one owner, they are permitted to hire others. If a sole trader decides to close his or her business, he or she can sell all of the assets and turn off the lights. Obtaining approval from others is not mandatory.

#4. Less stringent compliance requirements

As a sole trader, you are subject to fewer statutory obligations than a limited company director. There is no need to register with Companies House or file a confirmation statement on an annual basis, and there is generally less paperwork.

#5. Effortless termination or transition

To close a sole trader business, you must notify HMRC that you have ceased to be self-employed, finalize your income tax, pay Capital Gains Tax (if applicable), and offset the costs of closing down against your tax bill.

This is simpler and less expensive than other business structures. If you decide to close your limited company, you must notify HMRC and file a final Corporation Tax return. In addition, depending on whether your company is solvent or insolvent, you must apply to strike it off the register, initiate a Members’ Voluntary Liquidation, or arrange for its liquidation.

It is also easier to transition from a sole trader/proprietorship to a limited company rather than the other way around. It is simple to set up.

#6. The owner receives all of the profits

Finally, sole traders keep all of the company’s profits for themselves. They are not required to share income with other stockholders or investors, as they would be in a different sort of corporate structure like an LLC.

Disadvantages of Being a Sole Trader 

There are substantial advantages to being a sole trader. It’s simple to set up, doesn’t require a lot of legal fees, and the owner gets to retain all of the revenues. However, like the advantages, there are numerous disadvantages to operating as a sole trader that a small business owner should consider before making the decision.

#1. Raise Capital Is Difficult

What happens when the company begins to expand and requires funds to do so? Where is the money going to come from? A sole trader cannot raise funds by selling stock or attracting unrelated investors in other ways. Since it’s somewhat difficult to obtain outside financing, the owner must rely on his own savings and loans from friends and family.

#2. Liability is limitless

The most serious disadvantage of a sole trader is, without a doubt, the infinite exposure to liabilities and lawsuits. Unlike a corporation, the owner’s personal assets can be taken in the event of legal action. The owner and the company’s finances are the same. They are not legally divorced. This means that the owner may lose his home, automobiles, bank account, and any other personal assets in order to settle any business debts or avoid bankruptcy.

#3. Lenders are becoming more cautious

When granting loans to a sole trader, lenders are particularly concerned about hazards. Banks prefer to base their loans on a company’s financial accounts rather than the owner’s assets. Quite often, the owner’s credit rating is insufficient to meet the lender’s requirements.

#4.Business Liquidation

When the owner dies, the company will be liquidated. A sole trader, unlike a corporation, does not survive unless the owner has made plans to leave the assets to someone before his death.

Starting a business as a sole trader is appealing since it is inexpensive and requires little documentation. The sole trader should, however, carefully evaluate both the advantages and disadvantages of unlimited liability and the difficulty of raising capital. As a company grows, these variables will become more important.

#5. Everything is within the owner’s control

Initially, the sole trader makes all of the decisions and does the majority of the work himself. Doing everything may be OK at first, but as the business expands and more staff are added, it becomes more challenging. Another unexpected effect of a single trader is that as the business expands and hires more employees, the owner is frequently the last person allowed to take a vacation or celebrate a holiday. Employees are always allowed to take vacations, while owners are rarely allowed to do so.

Tax Factors of a Sole Trader

Since sole proprietorships don’t exist away from their owner, the tax implications, potential dangers, and restricted finance choices for a sole trader differ from those for someone who forms a corporation or seeks additional owners.

#1. Personal Responsibility

A sole trader is personally and directly liable for the business’s liabilities, including those resulting from his workers’ reckless or wrongful activities. A creditor can seize the owner’s personal assets, such as the home or other property not used in the business, to fulfill a judgment. 

The use or registration of a fictitious name, a trading name, or a “doing business as” does not protect the owner’s personal assets. To protect their personal assets, business owners who engage in activities that pose a high risk of personal harm or property damage may choose to incorporate, form a limited liability corporation, or get insurance.

#2. Taxes on Employment

On the net income earned by the firm, the sole trader pays a self-employment tax for Social Security and Medicare. As of 2013, profits up to $113,000 are taxed at 12.4 %, with the sole trader paying 2.9 % of all profits to Medicare. 

The sole trader can deduct half of his or her self-employment taxes from adjusted gross income; this is an “above-the-line” deduction, meaning he doesn’t have to choose between the standard and itemized deductions.

#3. Business Continuity

A sole trader has a finite lifespan; it comes to an end when the owner dies, retires, or is compelled to shut down the company. The corporation, on the other hand, survives the death or withdrawal of stockholders as a separate entity. There are no taxes due to the termination of the proprietorship on its own. Only if he sells property utilized in the business for more than the purchase price does the owner have to pay taxes; if the sale produces less than the cost of purchasing the asset, he can claim a loss.

#4. Taxes on Income

A sole trader pays taxes on the profit, which is recorded on his Form 1040, Schedule C. As a result, he avoids double taxes and benefits from lower tax rates than a corporation. Dividends, interest on bonds or savings accounts, and non-business expenses are all excluded from the profit calculation. 

Furthermore, employee payments are deductible as business expenditures, while payments to the owner are not. Charitable donations, medical costs, residential property taxes, and other personal expenses are not deductible from business earnings, but they can be recognized as bottom-line deductions if the owner opts to itemize instead of taking the standard deduction.

#5. Financing

Sole proprietorships have the least access to capital of all the business structures. Although lenders may be more inclined to lend to a sole trader with a considerable net worth and a good reputation, the owner must frequently rely on consumer loans and savings for funding. A sole trader has trouble hiring personnel due to a lack of cash. As a result, he may be a viable alternative for business owners that just require a few staff and minimal equipment.

Frequently Asked Questions