What is a sole trader? | Sole proprietorship meaning
Tips / 24.11.2021
One of the first things you need to do when thinking of starting up your own business is to determine your business structure. Will you be a sole trader or a limited company?
This distinction is crucial as it will determine not only what type of profit and income you make but also your debts and liabilities, as well as legal obligations.
In this post, we look at the meaning of a sole proprietorship to give you a better idea of what to expect and if this business structure, which is followed by 3.5 million people in the UK, is right for you.
Let’s see what a sole trader is.
Table of Contents
What is a sole trader business?
As a sole trader or sole proprietor, you are essentially your business. Many such business owners use their own names as the business name and operate as such.
This can give you a lot of flexibility. Additionally, the amount of red tape and bureaucracy required to start and maintain your business is not as stringent as other types of business structures. However, this also means that while the profits you earn are considered your personal income, the authorities will tax you accordingly.
In addition, the part that no one really likes to think about is the fact that your expenses and business liabilities become your own personal expenses and liabilities, and if your business goes under, your debtors will look to retrieve their funds from you personally.
This could lead to legal actions in which your property or assets such as vehicles and immovable property are ripe for the taking in order for your debtors to recover their funds.
How does a sole proprietorship work?
This type of business structure enables you to carry out your business as you normally would. However, with more control over your profits and income after tax, more say in how you run your business, you’ll encounter less red tape in running it.
As a sole trader, this doesn’t mean that you don’t have anyone else working for you. You are free to hire staff, but you need to make sure you make the necessary deductions from their monthly income for tax purposes. Speaking to your accountant regarding this area of your business is a good idea.
What’s more, is that you still have to follow rules regarding the registration of your business name. It’s also wise to keep separate bank accounts for your personal and business expenses and income. Next, you are required to register your business with the HMRC and pay tax.
There are some differences with other company types that can be quite liberating. For example, you aren’t required to register your business with the Companies House or make continuous filings of information with them.
It’s just you in the business and no other directors to run it. This also means no shareholder who invests capital in your business, but rather, the funds you raise yourself.
As a final difference, you are not linked to other partners such as in a general partnership, which means you don’t need to share your business rewards with anyone else, but it leaves you with more responsibility to handle matters on your own.
Examples of sole traders
Some examples of sole traders are freelancers, such as designers, copywriters, marketers, photographers, and social media consultants, also self-employed tradespeople – builders, plumbers, electricians, gardeners, and carpenters, and gig economy workers like couriers, taxi drivers, delivery drivers, tutors, and nannies.
Advantages and disadvantages
More control and oversight
There’s no need to consult other directors or shareholders, enabling you to develop your business as you see fit.
You will have far more “operational flexibility” than a more corporate business. This relates to changing your product or service offering, amending your prices, listening to your customers, and enjoying offering a more personalised service as opposed to something with a corporate feel.
It’s simple to begin
This business structure is one of the easiest and fastest to set up, although this still means informing the HMRC that you are self-employed and operating as such.
Inexpensive to start
You do not need the services of a formation agent or solicitor to get started and can eliminate these fees entirely. Also, you don’t need to pay fees to the Companies House.
You will, for example, not be required to provide formal Annual Accounts or a Corporation Tax Return. While you’ll still need a record of your invoices and expenses and a Self-Assessment Tax Return, this will reduce your accounting bill.
Fewer legal obligations
This essentially means less paperwork and more time to focus on your business as you will not need to update the Companies House of a change in directors or anything related to this as it’s simply not relevant to you.
You can also enjoy some allowances on business assets and expenses to conduct your business. Some examples are IT equipment, machinery, tools, office furniture, or even vehicles.
There’s no one else to share your profits with and you can enjoy the fruits of your labour without having other stakeholders to consider.
A limited company’s results are published, and anyone can, in theory, inspect them. Meanwhile, this business structure enables you to keep your financial information private. This is especially good if you don’t want your competitors to know about your financial position or other sensitive business information.
You can always change your mind
If you’d like to shift to another company structure in the future, this is possible as well, enabling you to not only change your mind but also grow as your business needs expand.
You are personally liable
Your business’ debts and liabilities become your personal debts and liabilities. Moreover, debtors can go after your personal assets to recover unpaid money.
Not too prestigious, according to some
There’s a perceived lack of prestige with a sole proprietorship, although this perception is not entirely accurate. This may also mean that some clients will not deal with you because of your business structure.
Some sources show that the self-employed trader is likely to pay more in tax than those in a limited company.
Less access to financing
This can be the case if you’re seeking to expand your business. Banks are more likely to look at the accounting transparency that comes along with a limited company as opposed to sole traders. This, in addition to the greater risk involved.
It’s lonely out there
While you are perfectly entitled to hire employees, the ultimate responsibility for absolutely everything in your business rests on your shoulders.
Limited business continuity
It will be hard to keep your business going if you choose to retire, or worse, you pass on. And if you choose to sell your business, it will be harder to do so, especially if you’re operating under your own name.
It’s a lot to shoulder on your own
If you don’t hire any employees, all the work is left to you. This may mean working early mornings and late evenings to ensure you stay on track, leading to a poor work-life balance.
Sole trader vs limited company
As a limited company, income, profits, assets, expenses, and liabilities are all separate from the person who runs the company. This essentially means that if your business fails for some reason, debtors will not chase you to settle debts in your personal capacity.
Another distinction is the tax requirements and paperwork required, as well as the statutory bodies that you report to.
What’s more is that with a limited company, you’re more likely to secure finances for your business growth and expansion, you’ll have other individuals involved with whom to share your ideas, but your accounting responsibilities will be greater.
Sole trader vs self-employed
Although some may argue that there’s a difference between being a sole trader and being self-employed, there’s actually no difference. As a sole trader, you are essentially a self-employed individual.
How to set up and what you need to get started
Here are some steps you need to take in order to get started with your business:
- Register in-person or online with HMRC
- Get the local permissions to operate your business
- Create a separate merchant account
- Find suitable premises
- Register for VAT
- Register a PAYE scheme if you intend to hire people
- Make sure your business is insured
- Consider how you’ll finance your business
- Make sure that you can accept payments with a card machine or process them online
As a sole trader, you’ll need to complete and submit a self-assessment tax return annually. This will set out your income and expenses. Furthermore, you’ll be required to pay income tax that’s based on your taxable income. This is paid to HMRC. You’re also responsible for national insurance contributions (NICs).
If you’re VAT registered, you will need to complete VAT returns regularly and make subsequent VAT payments. Tax owed must be paid by 31 January following the end of the tax year to which it relates. You’ll also need to collect income tax and NICs for your employees, along with following a PAYE scheme.
Finally, you’ll be required to keep accounting records of your sales, expenses, and income, although the requirements for this are not as strict and you’re relatively free to follow an accounting structure you choose.
With this post, we hope we’ve given you a comprehensive enough definition of what a sole trader is. However, it’s always important to consult an accounting expert before you embark on your journey.
Going into business on your own can be one of the most rewarding things you ever do, not looking back on the day you went solo. Sure, it will take hard work, effort, and determination, but ultimately, setting up is not as difficult as a limited liability company and the profits are entirely yours to do with as you wish. Also, any business success will be attributed to your efforts and hard work and no one else.
Disclaimer: Please be aware that the contents of this article and the myPOS Blog in general should not be interpreted as a legal, monetary, tax or any other kind of professional advice. You should always seek to consult with a professional before taking action, since the particulars of your situation may materially differ from other cases.