The disadvantages of being a sole trader

Choosing to register as a sole trader might seem like an obvious decision, with plenty of well-documented advantages to being a sole trader.

However, before launching any new venture, you must be well versed in the disadvantages of working under the sole trader status. They might sway you towards incorporating as a limited company.

If you feel torn between different trading styles, please get in touch with Harper James Solicitors to discuss your business objectives and help identify the best way forward.

Start-up businesses: deciding whether to become a sole trader

Registering as a self-employed business is undoubtedly the easiest route to getting a new company up and running.

But, the most straightforward option may not be ideal, depending on factors such as:

  • Your anticipated turnover
  • The business sector
  • Projected funding requirements
  • Your risk exposure appetite

While the administrative burden of a sole trader business may be lighter than incorporating a company, it’s crucial to understand when that additional paperwork might be worthwhile.

Personal liabilities and sole proprietor businesses

As a sole trader, the business owner and company are one and the same for legal purposes. So, you are liable for all company debts.

The proprietor bears any liabilities or obligations owed by the business, so there’s an increased risk that it will impact your personal finances and assets if the company fails.

In a limited company, the business is a standalone entity, so this level of personal risk doesn’t exist.

There are options to insure against such financial losses.

Still, it’s vital to be aware that business failure could, in the worst-case scenario, lead to severe outcomes such as bankruptcy.

Building reputational status as a sole trader

Another factor is that an incorporated business is often perceived as more legitimate than a sole trader.

While that doesn’t reflect the professionalism or conduct of the company, it remains true that many potential partners may be less likely to trade with a business that they can’t research online.

Limited businesses have a legal obligation to file documents and accounts. This makes it easier to apply for lending or pitch to investors who have a clear oversight of the trading history.

To build reputational status, sole traders can combat this disadvantage in many ways, such as:

  • Requesting customer reviews through third-party sites
  • Maintaining a visible, professional digital presence
  • Engaging with customers through social media platforms
  • Providing clear company policy documentation on their website
  • Publishing testimonials and client feedback

As a sole trader, you need to work harder to validate your company’s credibility due to the lack of information in the public domain.

How to attract new customers as an unincorporated company

Some businesses will only deal with limited companies in their supply chains.

If you’re wondering, can a sole trader have employees and compete against limited businesses in terms of capacity – they absolutely can!

However, you might find it more challenging to secure new business in some industries if your prospective clients don’t trade with sole proprietors.

This pitfall is primarily due to the perceived risk associated with the business model of a sole trader.

Establishing strong relationships and a track record of excellent service can help build a solid reputation to improve your chances of winning new clients.

The tax planning downsides to sole trader start-ups

Finally, it’s essential to assess the tax efficiencies of trading as a self-employed business.

Limited companies pay corporation tax at a standard 19% rate, which is substantially lower than income tax brackets for sole traders.

Other restrictions include:

  • The inability to draw dividends, which usually carry a lower tax charge.
  • Essential tax planning to align drawings with the appropriate trading period – as leaving profits in the business to draw later may result in a higher personal tax liability.
  • Exclusion from corporation tax allowances, with some self-employed expenses not treated as deductible as they would be for a limited business.

While these disadvantages are a general overview, they don’t necessarily mean that being a sole trader isn’t the right option for your business.

Tax efficiency depends very much on your circumstances and the finances of the business itself.

If you’re unsure whether a sole trader structure is an optimal solution for your start-up, please get in touch for independent advice about all the pros and cons to factor into your decision-making.

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