While setting up as a sole trader is the simplest way to dip your toe into self-employment, it’s not right for everyone.
Alongside big upsides, being a sole trader also has downsides. So, depending on your goals and the nature of your business, a different structure might be a better choice.
To help you decide, we’ve put together a list of the main advantages and disadvantages of doing business as a sole trader. Here’s what you need to consider before you make your decision.
What are the different ways you can structure your business?
Before we dive into the pros and cons of registering as a sole trader, it’s worth taking a quick look at your options when setting up a business.
In the UK, there are three main types of business structure:
Sole trader
This is where you run your business as a self-employed individual and enter contracts and other business-related obligations in your own name. All the rewards are automatically yours. But you also take all the risk
Partnership
As the name suggests, a partnership is an association between you and one or more other people.
Incorporating as a limited liability company is the most involved — and expensive — way to do business.
You’ll need to register with Companies House, appoint one or more directors, and issue share capital so shareholders can own a stake in the company. There are also ongoing obligations you have to comply with, such as filing annual accounts and holding annual general meetings.
The upside is that, out of the three business structures, it’s the most low risk.
If you’re planning to be in business for yourself, a partnership isn’t an option. This is because, by definition, it’s an association of two or more people. In comparison, you can be the sole director, shareholder, and employee of your limited company.
This means that, in practice, your choice when going self-employed is between registering as a sole trader and setting up a limited company.
So how do you decide between the two?
What are the advantages of being a sole trader?
Registering as a sole trader has four big advantages compared to incorporating as a limited liability company:
It’s simpler
It’s more cost-effective
There’s less admin
Your business affairs remain private
Keeping things simple, straightforward, and low cost
If you’ve decided being a sole trader is the way to go, you can register in under five minutes. Even better, registering is free. There are no fees to pay. All you need to do is one of the following:
Log on to HMRC’s website and register for self-assessment
In comparison, incorporating a company is more complicated. You’ll need to prepare a memorandum and articles of association and provide documents to prove your identity. There’s also a £50 registration fee.
If you don’t fancy handling the paperwork and dealing with Companies House yourself, an accountant or company formation agent can incorporate your limited company for you. But this convenience comes at a price. You can expect to pay £150 or more.
The incorporation fees might not seem too high, until you consider that a limited company’s ongoing requirements are also tougher than those of a sole trader. We’ll discuss these requirements in a minute. But the bottom line is that a limited company is more work for your accountant, and their fees will reflect this.
Less admin, less stress
When you’re a sole trader, you are the business. And this makes things a lot simpler.
As a sole trader, you have to keep a record of your transactions and store your business-related receipts. You also have to file a self assessment tax return, pay income tax and National Insurance, and register for VAT if you go over the VAT threshold.
This sounds like a lot of work. But using accounting software makes it all quite straightforward.
In comparison, being a limited company involves much more admin.
Alongside the responsibilities you have as a sole trader, you’ll need to draft and file company accounts with Companies House every year. There’s no law that says you must hire an accountant for this. But given the steep penalties if you file late or make mistakes, it’s probably best if you do.
More to the point, a limited company is a separate and distinct legal person. And this means that, where your sole trader income is automatically yours, a limited company’s income belongs to the company.
As a result, to take money out of your limited company, you’ll need to:
Issue a dividend. There are rules around when you can issue a dividend. In particular, you can only issue a dividend from your profits. You’ll also need to draft and sign a document called a dividend voucher
The bottom line is that you have less flexibility as a limited company than you do as a sole trader.
Your business affairs are private
Put simply, when you’re a sole trader, nobody will know what your financials look like unless you tell them. So, if keeping your business affairs private is important to you, this is the way to go.
In comparison, anyone can look up any company online for free, find out who the directors are, and look through their annual accounts.
What are the disadvantages of being a sole trader?
One of the biggest advantages of being a sole trader is also its biggest disadvantage. You are the business. So, if things go wrong and your business falls into debt, all your personal property — this includes your house — might be at risk.
Similarly, if you get into a serious disagreement with a supplier, client, or employee, you can get sued in your personal capacity.
By contrast, because a limited company is a separate legal person, you’re protected. Provided you don’t do anything illegal, it’s your company’s assets that are at risk if you get into debt.
In the same way, suppliers, clients, and employees deal with your company, not with you. So if there’s a disagreement, it’s the company that will get sued.
Being a sole trader also has other disadvantages. In particular:
Some businesses might not want to work with sole traders. This is because a sole trader is a more risky business structure than a limited company. Highly regulated industries like financial services are especially averse to dealing with sole traders
It’s harder to qualify for a business loan or get other funding, again because a sole trader is a risky business structure
When your revenue goes above a certain point, you may find that doing business as a limited company is more tax-efficient. This is because you can pay yourself a small salary and take most of your income as dividends. Dividend tax is 7.5%, significantly lower than the 20% basic rate of income tax. That being said, ever since the government lowered the tax-free dividend allowance to £2,000 a year, the tax advantages for limited companies have decreased
Putting it all together: which is better, registering a sole trader or incorporating as a limited company?
The short answer is, it depends. Ultimately, it’s all about risk and reward.
A limited company is lower risk, so it could be the way to go if:
Starting your business requires significant upfront investment, for example because you need to buy expensive machinery
You need to get outside funding, such as a business loan
You’ll be working in a highly regulated industry
In these cases, the benefits from minimising your risk is worth the extra costs and admin headaches involved.
On the other hand, registering as a sole trader might be a good choice if:
The business is relatively low-risk, for example because you’re a marketing consultant or sell consumer goods online
Your startup costs are low
You’re building things up on the side. You can always incorporate your business as a limited company if and when it takes off
Still not sure which way to go?
It’s worth having a chat with an accountant so they can give you personalised advice.
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