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.
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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.
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
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 acclimate.
We’re not saying this to scare you into not making any moves or chances 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. Â
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.
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 2 and 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
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 and ensure that your class 2 National Insurance payments are stopped, as you’ll be taxed in a different way as a limited company.
- 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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