Becoming a sole trader can be extremely rewarding; however, there are a number of pros and cons to consider before making the change to self-employed:
The Pros of Being a Sole Trader
The Cons of Being a Sole Trader?
Self-employment shows no signs of stopping and working as a sole trader is the option of choice for many individuals embarking on this self-employment journey for the first time – when compared to other structures, such as limited companies, being a sole trader can be the most convenient solution.
However, it’s important to weigh up the pros and cons before making that decision. After all, what suits one person may not be the best option for someone else, so knowing the advantages and downsides of operating as a sole trader, no matter the industry or specialist sector you’re in, is key.
What Does it Mean to Work as a Sole Trader?
You can choose to operate through several types of business structure, and no approach is better than the other. It all depends on your circumstances and how you wish to run your business. As sole trader accountants, we often see people wonder what ‘sole trader’ actually means and whether it’s the right business structure for them.
To clarify matters, we’re first taking a look at what being a sole trader entails.
Simply put, a sole trader runs their business as an individual. There is no legal distinction between the owner and the business, which can have its advantages and disadvantages. Everything belongs to you, from business assets and profit to liabilities. You may need to register for self-assessment with HMRC and should keep appropriate financial records, as well as pay all taxes you’re due. You have to track eligible expenses, issue invoices and submit self-assessment returns.
We recently published an article on how to be a successful sole trader, which can help you to learn more about this type of structure and how you can leverage it to your advantage.
What are the Benefits of Being a Sole Trader?
The sole trader structure is the most popular in the UK. This is not surprising, considering the many advantages of becoming a sole trader and how easy it is to set up a business. So, how exactly can you benefit from this business structure?
Being a sole trader means more control for you. You run your business the way you want, without interference from anyone else, from daily tasks to strategic decision making. You don’t have to consult directors or shareholders either, which means you won’t have to compromise your vision. You can make decisions, act on them quickly and meet your clients’ needs without delays.
It’s highly likely that you became self-employed – or are looking to make the transition – so that you could have the freedom to work the way you want to. By being a sole trader, you are able to focus solely on your business and run it the way you want.
This also means that all the after-tax profits you make are yours. Sole traders don’t have shareholders to pay or split profits with so, if you work alone, you have the ability to maximise your potential profit and ensure costs are low. If you decided to form a partnership, you’d have to share your business’ profits.
Another reason why many individuals choose to become a sole trader is the ease of setting it all up. In essence, you only need to let HMRC know you are now self-employed by registering for self-assessment as a sole trader and choose your business name. And you’re done. Apart from any industry-specific licenses you may have to obtain, you can start trading instantly. You don’t have to register with Companies House because you don’t own a company.
There are some considerations to make when choosing a business name as a sole trader, however, such as the fact that you can choose to trade under your own name or opt for something different if you prefer or if it makes more sense to your business. You have to include your name and business name – if you choose one – on official documents, like invoices.
As a sole trader, you can’t include words like ‘limited’, ‘Ltd’, ‘public limited company’ or ‘limited liability partnership’ in your name. Naturally, you have to stay clear of any offensive names, as well as of existing trademarks, and can’t suggest a connection with government or other authorities without permission.
Not only is it easy to start working as a sole trader, since there isn’t much paperwork to fill out, but there is also less admin overall. As a sole trader, you will need to keep accurate records of your expenses and sales, but you will only need to submit a self-assessment return. If your turnover is above the £85,000 threshold, you may have to register for VAT.
If, on the other hand, you were forming a limited company, you would have to appoint a director, allot new shares, etc. None of this applies when you’re a sole trader, so you will spend less time doing admin – time that can be spent growing your business.
If you own a limited company, your accounts and specific details about the directors are available for public inspection on the Companies House website. This means that anyone can access this database and search for your business details. However, as a sole trader, you are granted privacy by HMRC’s taxpayer confidentiality rules. Your private information and your business details won’t be visible to anyone, so your competitors won’t be able to gather information about you.
One way to decide which business structure is the right fit for you is to consider the nature of your business. For instance, it may be best for you to work as a sole trader if you provide a personal service that requires making use of your personality. It’s difficult, or downright impossible, for limited companies to have as much character or individuality as sole traders, which means you can stand apart from other businesses by injecting a personal touch.
If you change your mind and don’t wish to continue working as a sole trader, you have the chance to incorporate your business if you so wish. Going from operating as a limited company to working as a sole trader is not as easy, since it means you’d have to go through the process of dissolving the company and stepping down as director, for example.
If you believe you’d benefit more from registering as a limited company, there will be no impediments to making the switch, apart from having to fill out more paperwork and pay tax as a limited company. Additionally, starting as a sole trader means you can dip into the self-employment world with ease before deciding this is the path you’d like to follow – if you find that self-employment is for you, then you can just become the director of your own limited company.
As limited company accountants, we can help with the transition.
What are the Disadvantages of Becoming a Sole Trader?
While there are plenty of benefits to working as a sole trader, there are also some downsides to keep in mind. Being aware of the disadvantages of this business structure can help you to make a decision before taking the leap into self-employment.
The biggest disadvantage of this type of business structure is the fact that you’re responsible for your business’ debts. You are legally responsible for all elements of your business and have what is called ‘unlimited liability’; this means your personal assets could be at risk. As a sole trader you don’t share profits with anyone else, but this also means you can’t share your debts and losses with business partners, leaving you with the burden.
Because sole traders aren’t able to offer shares in their business, it’s more challenging to raise much-needed capital. Should you choose this structure but know that you’ll need financing, you will likely have to turn to financial organisations like banks, for example.
Having full control is certainly an advantage, but it can also be a downside, depending on how you see it. All business decisions have to be made by you, which means the success or failure of your business hangs solely on you as well. For some, this can be incredibly stressful, especially if there are outstanding debts to consider or crucial strategic decisions that impact your business.
As a sole trader, you’re also running the day-to-day of your business all by yourself, since everything is your responsibility, so it can be difficult to take a break or a holiday. This also means that your business will stop if you are unable to work. Be it due to sickness, injury or any other reason, it’s important to consider whether this is the right business structure for you if there’s a risk of income loss if you’re unable to work.
Limited companies are typically more tax efficient than sole traders, since they allow income to be maximised and tax minimised. Sole traders have the same tax status as individuals, with a tax-free personal allowance of £12,570 for the 2021/2022 period. You start paying tax on income above this figure, which stands at 20% between £12,570 and £50,270, 40% for income between £50,271 and £150,000 and 45% for anything above £150,000. National Insurance Contributions may also be due.
Sometimes, sole traders are seen as less professional when compared to limited companies, which makes clients less likely to work with them. For this reason, you may find it difficult to get larger jobs. This is more common if you’re trying to work with big corporations, for instance. Having to find and chase potential projects that may not work out in the end is also time-consuming.
Looking for contractor accountants that can guide you every step of the way? At Gorilla, we take great pride in helping self-employed individuals set up and grow their business, so get in touch and we’ll help you decide which business structure is right for you. After all, while starting out as a sole trader will give you flexibility, is cost-effective and has less paperwork to deal with, it also comes with certain downsides.
We also offer a contractor tax calculator, which will help you to figure out your take-home pay.
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