The Biggest Disadvantages Of A Sole Trader

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Being a sole trader is the easiest and fastest way to get your business up and running.

With less red tape and legal forms to go through, it makes sense that 60% of all small businesses in the UK are currently set up as sole traders. 

However, being a sole trader isn’t the only company structure that exists. The simple truth here is, although a sole trader might work for some and can be a great starting point, there are a lot of downsides that need to be considered. 

Only by weighing up the pros and cons can you ensure that you’re making the right decision for your company. So, without further ado, let’s start discussing the disadvantages of a sole trader.

What is a sole trader?

A sole trader is a type of business that’s owned and operated by a single person. It’s most commonly associated with trade businesses or contractors, such as plumbing, hairdressing, building, or photography. 

Because the business isn’t classed as its own legal entity, there are a lot of blurred lines between you and your business with a sole tradership. You are essentially the business, tending to provide your own service or skillset rather than a set product and handle all the financials yourself. 

Some people may confuse being a sole trader with being self-employed. Although there is a difference between self-employed and a sole trader, the core concept remains the same: you work for yourself. 

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What are the biggest disadvantages of being a sole trader? 

Now the definitions are out of the way, let’s get into the real meaty stuff and discuss the biggest disadvantages of being a sole trader. 

1. You’re legally responsible for your company 

Being a sole trader comes with the legal responsibility of answering for any mistakes or debts your business might have.

The good part of being a sole trader means being your own boss. You can set your own hours and work schedule, but people often skip over the flip side of this coin.

Being your own boss also means that any responsibility, decisions, or plans are yours to control and manage. And if something goes wrong, then you are on your own. 

When you’re a sole trader, there’s no legal distinction between you and your company. That means that you are legally responsible for your company and any debts you might accumulate. 

We’re not saying this to scare you into not making any moves or changes at all. But it’s worth remembering that 1 in 5 new businesses fail in the UK, and being prepared and knowing the full consequences of your actions is the way to ensure that your business will thrive.  

2. There’s no safety net 

As we’ve stressed before, you are legally responsible for your business as a sole trader. As well as owning all the decisions and possible debts that you might accumulate, we need to emphasise that there is no safety net as a sole trader. 

Being a sole trader doesn’t guarantee you a fixed income. If you don’t work and make profits, you won’t earn. This means if you want to take some days off on holiday or have to take time off sick, you won’t earn. 

Although you can take out personal accident insurance as a sole trader, which covers you in the event of a serious injury or illness, there’s no safety net for the little days here and there that you might need. If you don’t like the risk of not knowing when or how much money you’ll earn, you might want to consider switching to a limited company and paying yourself a secured monthly wage instead. 

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3. People view you as the little guy 

Because sole trader businesses are so popular for businesses starting out or with small trade operations like electricians, there’s a reputation that sole traderships are small, one-man shows. 

That’s not always a bad thing, especially if that’s what your client is looking for. For some industries, there’s a real bonus for being the little guy versus a cold, uncaring global conglomerate.  

However, if you’re trying to earn the big clients or secure high-profile contracts, this reputation could cut you unfairly out of the mix. When it comes to company formation types, you not only need to think about what’s best for you, but also what will help you secure the clients you need. 

4. You’ll face greater tax penalties 

Sole traders are responsible for paying: 

  • Income tax on all your profits
  • Class 4 national insurance
  • VAT (if VAT registered)

This is calculated and paid through your self-assessment tax return every year. As a sole trader, you will be allowed up to £12,570 tax-free as a personal allowance.

So if your profits fall under this amount, you won’t be liable for any income tax. In addition, there are a few allowable expenses that you can claim for, but frankly, not as much as a limited company can claim. 

Depending on your profits, it can be beneficial to be a sole tradership. But if you’re making more than £15,500 a year, the corporate tax rates will save you more money than paying personal tax, meaning that you’ll save more money as a limited company.

We’ve spoken about this in more detail in our guide on when you should switch to a limited company.

You can find out more about what tax you are eligible for and how to pay tax as a sole trader in the UK here. If you need more advice or information, we’d always recommend speaking to your accountant for tax advice and ensuring that you’re paying the correct amount. 

Don’t have an accountant yet? Find the top-rated UK online accountants for your business here. 

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5. Limited access to finance 

Most sole trader businesses are funded out of your own pocket or through personal loans. This is because sole traderships have limited finance options and will find it difficult to raise capital. 

Banks, in particular, will rarely offer business loans to sole traders because of the private nature of the company you operate.

There’s no legal distinction between you and your company, so it’s harder for banks to guarantee that the money will be used in the way that you asked for. If a loan is offered, the conditions and rates are often much worse than that offered to a limited company. 

Other sources of finance, such as government schemes, are often unavailable to sole traders. In addition, because sole traders don’t have company shares, you can’t get people to invest in your business the same way they would a limited company. 

6. You can’t sell the business 

We’ve said this before, and we’ll say it again. There’s no legal distinction between you and your company when you run a sole tradership.

That means you cannot sell your company because you cannot sell yourself. The company begins and ends with you. 

If you wanted to sell or transfer your company to another person, a sole trader would need to register as a limited company in order to gain and transfer shares over to another person.

Unfortunately, if you’re looking to sell, you might have to become a limited company in advance before sellers will even consider you as an attractive buying option. 

7. There’s a poor work/life balance 

Long nights and lots of caffeine can sometimes be a pretty accurate description for a sole trader. Be aware of this.

This doesn’t go for all sole traders, but in a lot of cases, there can be a poor work/life balance associated with these company types.

That’s because the profits of the company, and therefore your income, are directly influenced by how much work you put into the company. 

If you take days off or go on holiday, you don’t earn. So, a lot of sole traders forgo days off to secure their income, which can cause a lot of stress and burnout later down the line.

If you are to run a sole tradership, it’s important that you recognise the importance of that work/life balance and take time for yourself. 

What are the advantages of being a sole trader? 

Now we’ve covered the main disadvantages, it’s time to remind you that there are some advantages to being a sole trader. This includes: 

  • Being your own boss, setting your own work hours and schedule, and being able to make all the decisions yourself
  • Having less red tape and legal paperwork to submit each year
  • Having more privacy and the ability to protect information rather than have it publicly displaced on the Companies House
  • Not paying Corporation Tax, which can mean less money lost to tax in certain circumstances

If you want to read more about the positives of being a sole trader, you can see all of these in more detail here. 

Can you change from a sole trader to a limited company?

Yes! You absolutely can change from a sole trader to a limited company. It’s a common practice that a lot of businesses go through, as the freedom of a sole tradership can be great for starting out.

Still, as you develop your business, you may find that you need the increased protection, liability, and tax benefits a limited company can provide. 

Changing from a sole trader to a limited company is a relatively easy process.

All you need to do is: 

  • Register your limited company with the Companies House. For this, you’ll need your company name, details of your directors, and who gets shares (in most cases, this will just be you!) and complete all official documents and application forms. You can find out more details about what this involves here. 
  • Get in touch with HMRC and inform them of the change in your company structure. You’ll also need to de-register as self-employed.
  • Finally, let your accountant know. Preferably, you would discuss this with them before the change as well, but you definitely need to inform them when any changes are made, so they can ensure you’re following the correct tax procedures and paperwork.

Want to do it yourself? Discover the process in more detail with our guide on changing from a sole trader to a limited company. 

Or, if you’d rather have someone take care of it for you, then you should talk to one of our best-rated company formation agents. Not familiar with company formation agents? These are professional agencies that specialise in registering businesses at Companies House.

They take care of all the legal paperwork, ensure everything is in order, and speed up the entire process for you. What’s more, company formation agents can also provide additional services, such as providing UK Registered Office addresses if you want to protect your private information. 

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Transitioning to a limited company: what you need to know

Transitioning from a sole trader to a limited company can be just the thing your business needs to progress to the next level and reach your goals. But becoming a limited company does bring about more responsibilities, which you need to be aware of. This includes:

Financial Separation

  • Dedicated business bank account: You need to open a separate bank account for your limited company. This keeps your personal finances and business transactions distinct, as you and your limited company are now classed as two separate entities, and you cannot run a limited company using your own personal bank. 
  • Asset transfer:  If you have assets that you purchased as a sole trader (such as equipment or vehicles), you might want to transfer them over to the limited company. However, the tax can vary depending on the asset type and value, so always speak to an accountant first for advice on the most tax-efficient approach to transferring ownership.

Regulations

  • IR35 compliance:  Limited companies hiring contractors or freelancers need to be aware of IR35 legislation. This prevents tax avoidance by ensuring contractors are correctly classified, which means contractors can’t secretly claim the benefits of being an employee without being classed as one.   To avoid hefty fines and tax burdens, maintain meticulous records and contracts for all workers. This includes verifying they don’t receive employee benefits and creating Status Determination Statements to prove proper classification.

Tax & returns

  • Tax: Moving from a sole trader to a limited company means that your tax obligations have also changed. Instead of paying income tax and NIC contributions on your profits, your business will pay corporation tax instead, which can result in bigger profits for your company. 
  • Annual returns: a limited company needs to file annual confirmation statements to the Companies House and submit annual accounts at the end of every financial year. 
  • Allowable expenses: Similar to sole traders, limited companies can claim allowable expenses that are “wholly, exclusively and necessary” for business operations – such as for travel, utilities, and insurance. The claiming process differs slightly, though. You have two options:
    • Direct payment: Pay the expense directly from the company business bank account. Retain receipts and records to claim deductions when filing annual returns, lowering your tax bill.
    • Reimbursement:  Pay the expense personally from your personal account. Then submit it as a reimbursed expense to the company. The company reimburses you, and both the expense and reimbursement are documented in the company accounting records.

Tip: Accounting software is a must here. It streamlines expense tracking, saving you time and ensuring everything is properly documented.

Payroll 

  • Salary & dividends:  As a limited company, you and the company become separate legal entities.  You can’t simply take company profits for personal use. Instead, you need to pay yourself through a salary (a set monthly wage) and can also receive dividends to receive company profits. 
  • Payroll setup (even for one):  Even if you’re the sole employee, you still need to set up payroll and pay yourself wages through the PAYE system (Pay As You Earn). This ensures proper tax and National Insurance contributions are made.

Insurance

  • Review & take out new coverage:  Any insurance policies that you have as a sole trader need to be reviewed and updated to your limited company’s name. Depending on your business needs, you might need to adjust existing coverage or acquire additional policies. For example, Employers’ Liability Insurance is mandatory if you employ staff (which you now are!). 

But making sure that you’re aware of the responsibilities and what it entails will help ensure that the process of changing from a sole trader to a limited company is as smooth as possible. 

Need more information? 

At Business4Beginners, our goal is to help you build and grow your business. Whether you’re after legal advice, accountancy help, or software reviews, we’ve got your back. 

Keep updated with all the latest news and trends here.

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Author
Business4Beginners has been advising new businesses owners since 2013. The founder, Paul Bryant, has created, grown and sold several successful businesses and remains the editor and fact-checker of all content published on the site.
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