Are there any Disadvantages of being a Sole Trader

One of the most important decisions you’ll make when you start out in self-employment is which business structure you’ll operate through. The majority of self-employed people will run their business either as a sole trader or through their own limited company.

There are a lot of factors to weigh up and the decision depends on your circumstances and business goals. While there are plenty of benefits to working as a sole trader there are also some downsides, and in this post we’ll examine some of the main sole trader disadvantages.

More Financial Risk

One of the biggest disadvantages for a sole trader is that they are personally responsible for any debts incurred by their business. With a limited company structure, the business is a separate legal entity from the owner which draws a clear distinction between business and personal finances. This is known as limited liability as the financial risk for the director is limited only to what they have invested in the business.

This is not the case for sole traders who have unlimited liability. This means that their personal assets such as their house, car, or investments could be at risk from creditors should their business default on debt. As a sole trader, you don’t share company profits with anyone else, but you also have sole responsibility for any business debts.

Reduced Tax-Efficiency

When you operate through a limited company there is an opportunity to leverage tax-efficiencies and deductions which sole traders don’t have. This is a significant disadvantage for sole traders that can negatively impact their take home pay.

As a limited company director, you can pay yourself a small salary at a tax-efficient level then supplement your income through dividend payments. Dividends are company profits distributed to shareholders after tax, and they are taxed at a lower level than income tax on business profits, plus they aren’t subject to National Insurance deductions. This means that with the right remuneration structure, limited company directors can retain more of their earnings than sole traders.

Sole Traders pay income tax at a rate between 0% and 45% on their company profits after any allowable expenses are deducted.

It’s Harder to Raise Capital

A disadvantage for sole traders that are looking for investment to help scale their business is that it’s generally harder for them to secure funding and investment.

As a sole trader you can’t offer shares in your business and banks and lending institutions will generally look on you less favourably if, for example, you’re seeking a business loan as they perceive personal ownership to be a less stable business structure compared to a limited company.

Limited Growth Capacity

It’s harder for sole traders to scale and grow their business and this is a key reason why many choose to incorporate in time. As well challenges faced raising capital, as the business grows the time pressure increases and many sole traders can hit a glass ceiling in this respect. Ultimately the potential of a sole trader business is linked to the skills, motivation and time the business owner can provide.

Running your own business is demanding as you have to actually do the work plus marketing and securing new work as well as making sure your accounting, reporting and tax obligations are met. You can take on employees provided that you remain the sole owner of the business, but you’ll need to register as an employer with HMRC and set up a workplace pension scheme for any employees, then handling payroll will become an additional responsibility.

Less Favourable Perception of your Business

Sole traders can struggle in terms of how their business is perceived by potential clients. Limited companies are viewed as being more stable and professional which means potential clients will have more confidence and trust in them. In some sectors, clients will only work with incorporated businesses so sole traders may miss out on potential work due to not being limited.

Limited companies are monitored and regulated more stringently and have extra reporting and accounting requirements. Information regarding the business and directors is also in the pubic domain on Companies House which brings a greater degree of transparency and accountability that sole traders don’t have.

Sole Trader Accounting with Gorilla

Many self-employed people will start out as sole traders and once they build their business and become established, they will incorporate. A limited company structure does offer significant benefits including better tax-efficiency which can increase take home pay and financial protection thanks to limited liability.

There are of course many advantages to operating as a sole trader which we’ve explored previously. Sole traders have less onerous accounting and reporting obligations, less stringent compliance requirements and the simplicity, ease and low cost of set up makes it a perfect business structure for those starting out in self-employment.

Our sole trader accounting service means all your business and personal accounting needs will be expertly handled by your own dedicated accountant for only £50 + VAT per month. You’ll benefit from unlimited support and advice, full inclusive access to market-leading FreeAgent accounting software and a same day response to your queries thanks to our Client Service Guarantee.

If you’re a sole trader looking to incorporate, our Company Formation Service makes things simple. For just £100 + VAT we will handle the whole process for you and can usually have your business set up the same day. And our limited company accounting package will take care of all your business and personal accounting needs including support and advice regarding maximizing your tax-efficiency.

If you have any queries about the sole trader business structure or our accounting service, please call 0330 024 0406 or request a call back to speak to an accountant today.