Understanding the Disadvantages of Sole Trader Business Structure

When it comes to choosing what business structure is right for you, it’s important to understand the disadvantages and advantages of each structure so you can make an informed decision that’s right for your circumstances and ambitions.

The business structure you choose has significant implications in terms of the amount of tax you’ll pay and therefore your take home pay, the scope of your reporting and accounting obligations and the level of financial risk you face.

In this post we’ll break down some of the threats and disadvantages of the sole trader business structure to give those considering personal ownership an insight into some of the challenges they could face.

You Might Pay More Tax

As a sole trader you will pay income tax on your taxable profit at the relevant rate determined by which tax band your taxable profit places you in. Some allowable expenses can be deducted to reduce your overall tax liability, but ultimately the opportunities for sole traders to leverage tax optimisation strategies are restricted.

For those trading through their own limited company, there is much more opportunity to operate tax-efficiently and increase take home pay while remaining compliant. Generally limited company directors will pay themselves a small salary and then supplement their income with dividends which are taxed at a lower rate than income tax on salary, as well as claiming all allowable expenses and deductions, meaning they can reduce their tax liability and keep more of their earnings than sole traders.

You Face Increased Financial Risk

Sole traders face more financial risk than their incorporated counterparts. As a sole trader, you are considered to be the same entity as your business from a legal standpoint. This means that sole traders are personally liable for any debts incurred by their business, known as unlimited liability. Creditors could therefore pursue your personal assets such as your home, car or investments, to recover any monies owed.

By contrast, limited companies are a separate legal entity from the business owners with business and personal finances clearly split. Therefore, they benefit from limited liability which limits their financial exposure only to the amount that they’ve invested in the business which affords a degree of financial protection to those trading through a limited company.

Business Growth is More Challenging

Sole traders will generally find it more difficult to grow their business than if they were incorporated. There are various factors that contribute to making sole trader business growth more challenging. Investment and funding can be harder to secure due to lenders viewing sole traders as higher risk. There are assorted reasons for this with unlimited liability increasing the risk for lenders and business continuity also a concern should the owner be unable to work through illness or injury, for example.

Sole traders are also less stringently monitored with less financial reporting obligations than limited companies. This is a positive in some respects as it reduces the admin burden, but from a lenders’ perspective the reduced financial transparency amplifies the risk of engaging with sole traders. Sole traders are also unable to raise capital by issuing shares.

Due to there being no legal distinction between business and personal finances for sole traders, personal credit scores and histories can also adversely affect lending prospects if a credit score is poor. But conversely, a strong credit history can help. Sole traders seeking funding such as a business loan might also have to contend with less favourable terms, such as shorter repayment periods, as well as higher interest rates.

How Gorilla Can Help Sole Traders

There are, of course, also many advantages of the sole trader business structure. Business set up is quick, cheap and easy and you don’t need to register with Companies House. Regulatory and reporting obligations are relatively simple and you don’t have to contend with the complexities of Corporation Tax and Dividend Tax. Your details aren’t available in the public domain which protects your privacy, and you can keep all business profits after tax.

But it’s fair to say that it can be very demanding and challenging to build and run a successful business as a sole trader. Just doing the day-to-day work that you get paid for can take up a lot of your time, not to mention additional responsibilities such as admin, securing new work, getting contractor insurance in place and ensuring compliance with your tax and accounting obligations.

And this is where Gorilla can help! We offer a comprehensive sole trader accounting package for just £55 +VAT per month. All your business and personal accounting needs will be expertly managed by your own dedicated accountant, giving you more time to focus on your business instead of your bookkeeping, as well as peace of mind that your financial, tax and accounting affairs are in order. You receive full access to FreeAgent cloud accounting software and unlimited support and advice with a guaranteed same day response.

For sole traders that have decided to go limited, or those looking to start a limited company, our expert company formation service will complete the whole incorporation process for you from start to finish for only £100 +VAT.

For expert advice on which business structure is right for you, or to learn more about our accounting service, speak to an accountant today on 0330 024 0406 or request a call back.