A sole trader is a self-employed person who owns and operates their business as an individual, rather than through a recognised business structure such as a limited company or partnership.
As a sole trader, there is no legal distinction between the individual and their business entity. Sole traders are personally liable for all their business debts.
While a sole trader runs the business on own their own, it does not mean they need to be alone in the business. A sole trader can employ staff on a permanent or part-time basis.
The advantages of being a sole trader
As a sole trader, there is no need to deal with the formality and documentation involved with setting up a limited company or partnership.
You can start doing business straight away, without even needing to choose a business name or set up a business bank account.
Sole trader set up is free
There is no cost involved with starting business as a sole trader. Although the cost of setting up a limited company is minimal, there is no cost whatsoever with commencing as a sole trader.
Less administration and reporting
As a sole trader, there is no need to generate any annual business reports or make annual filings to Companies House, e.g. confirmation statement or annual accounts. The only paperwork which needs to be submitted is the Self Assessment tax return.
Sole traders have much more privacy in terms of their business dealings compared to limited companies.
There is no need to publish an office address or provide details of people with significant control over the business. Financials are not on public record and generally only need to be divulged for purposes of completing the annual Self Assessment tax return.
No directors’ duties
Sole traders are not subject to any of the requirements under the Companies Act 2006. In particular, they do not need to follow Chapter 2 of the Companies Act which specifies the general duties of directors, e.g. Duty to exercise reasonable care, skill and diligence.
Because sole traders do not have to consider any shareholders, they are not regulated in their actions and are therefore more at liberty to take financial risks. Conversely, if a company director makes a very risky business decision, this could contravene their directors’ duties under the legislation.
Sole traders can convert to a limited company relatively easily and quickly (see below) if they decide to adopt an official business structure.
There is no paperwork involved with ending the business as a sole trader, whereas closing a limited company is more difficult.
The disadvantages of being a sole trader
Sole traders are personally liable for any business debts.
Unlike an owner / shareholder of a limited company, there is no limit on a sole trader’s liability if the business gets into financial difficulty. Any debts owed to creditors will need to be paid out of personal assets if there is insufficient money in the business. This can extend to property including their own home, and can result in personal bankruptcy.
The unlimited liability of being a sole trader can be a huge risk for anyone with extensive personal assets. It is also possible this may prevent business expansion by those who are more risk averse.
Marketing and credibility
Some people prefer to deal with limited companies, as sole traders are often considered higher risk or less ‘professional.’
This perception is possibly due to a sole trader’s unregistered status, as all established and large businesses trade as limited companies. In business terms, people trust ‘big business’ as they feel they have the resources, infrastructure and willingness to fix things, should something go wrong while supplying their products of services.
Indeed this problem is magnified in the business-to-business sector, where most large companies have a policy of only dealing with other incorporated entities.
Sole traders can struggle to raise capital. Since they do not have to submit annual accounts, this reduced financial transparency can also reduce their ability to get bank loans.
Potential investors may also be put off as they cannot be offered shares within the business. Even if a sole trader is doing exceptionally well, they do not have the option of raising substantial capital, e.g. by being listed on the stock market as a public limited company.
Sole traders are required to pay personal tax on the full extent of their profits each year. They are unable to re-invest profits in the business through retained profits, as a limited company can do, and sole traders do not have access to the associated lower tax rates of Corporation Tax.
Furthermore, sole traders do not have the option of paying themselves with a combination of salary and dividends, and therefore do not have the tax efficiency afforded to shareholders of a limited company.
Transfer of business ownership by sale or succession
It is much easier to transfer ownership of a limited company than an unregistered entity.
Sole trader businesses cannot be seamlessly transferred to another party or a successor. However, ownership of limited companies can easily be sold or passed on to family members by simply transferring the shares. This will include everything, including clients, equipment and premises.
When a sole trader dies, their business effectively dies with them. Whereas with a limited company, as long as there is one director / shareholder in place, the company will continue to exist.
Business name protection
A sole trader’s business name has limited protection, and generally anyone can set up a business and start trading using the same name. The only protection open to an unregistered entity is the law of ‘passing off’ which is complicated and often unsatisfactory, i.e. it is not easy to prove the intention that someone is trying to steal your goodwill.
On the other hand, a limited company’s name is registered at Companies House, which means no one can register the same name or one that is deemed to be too similar to it. Many people set up a limited company solely for the purpose of protecting their business name.
1st Formations offers a Reserve a Company Name Package at a cost of £59.99 plus VAT. This package provides a limited company, registered office, confirmations statement and dormant company accounts service.
Can I switch from being a sole trader to a limited company?
Many sole traders decide to convert their business structure to a limited company once they reach a certain point, e.g. their annual turnover reaches a specific level or they wish to expand the business without increasing their personal risk.
The first step in this process is to register a limited company. This can be done from as little as £12.99 with 1st Formations. A good place to start is on our homepage where you can check if your desired company name is available. The application process takes about 15 minutes, and once complete, your new company should be approved by Companies House and ready to trade in 3 to 6 working hours.
As well as registering the company, there are a number of other things that need done. Here is a checklist of tasks involved in converting from a sole trader to limited company:
- Register a limited company at Companies House
- Inform HMRC that you have decided to stop being a sole trader
- Transfer your sole trader business and business assets to the limited company
- Set up a business bank account in your limited company name
- Notify stakeholders about the change of business structure
- Register your limited company for Corporation Tax and PAYE
Check out 1st Formations’ blog explaining the process in detail: How to convert from sole trader to limited company
So there you have it!
We have covered the advantages and disadvantages of owning and operating a business as a sole trader and also covered how to convert to a limited company.
If you have any questions, please leave them in the comment section below and we will get straight back to you!