Disadvantages of a Sole Trader

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We’ve already looked at the advantages of operating as a sole trader, but there are also important disadvantages that come with sole trader status. It’s for those reasons, and the advantages of incorporating your business, that many people choose instead to form a limited company.

1 Personal Liability

Sole trader businesses are not recognised as a separate legal entity. When you operate your business as a sole trader, therefore, its liabilities and debts are your liabilities and debts. If the business fails with debts to be paid, not only will you lose your income but you’d also have to pay the money owed from your assets, whether or not they’re connected to the business. Because that liability is unlimited you could also lose your home as well as potentially facing bankruptcy.

2 Perceived Lack of Prestige

A sole trader may not appear to have the prestige of a limited company. Even though in many cases it’s completely inaccurate, the public perception of sole traders is often of smaller, less long-standing and less professional businesses than their limited company counterparts. Professional credibility may in many cases lead you away from operating as a sole trader.

3 Some customers will not deal with sole traders

Often linked to this sense of prestige and the fact that sole traders are seen as higher risk, many clients will simply prefer to deal with a limited company. This can mean you lose out on business purely through setting your business up as a sole trader.

In some industry sectors, there’s effectively little option but to set up as a limited company. Before getting started, it’s worth doing some research into your market and potential customers to see whether you’ll be able to work as a sole trader or if you’ll instead need to form a limited company.

This restriction may extend from customers to suppliers, who may in some cases choose not to supply goods or services to a sole trader, or will do so but on less advantageous credit terms compared with a limited company. That again reflects the perceived risk involved with the sole trader business model.

4 Tax planning limitations

There are usually fewer tax planning opportunities in working as a sole trader compared with being employed by a limited company.

All profits earned by a sole trader are subject to income tax in the financial year in which they are made. That implies a number of restrictions:

  • Where the business makes significant profits, the self-employed sole trader will usually pay more in tax than their counterpart in a limited company. The employed owner of a limited company can chose to draw dividends from their company, which are for the most part taxed at a lower rate, meaning they’ll enjoy more take home pay.
  • Profits cannot simply be left in the business to be drawn as income in a later year, when your income (and potentially your personal tax rate) might be lower.

However, the tax-efficiency of any business structures depends on your personal circumstances. It’s always a good idea to consult a tax professional if you’re at all unsure.

5 Limited access to finance

As a sole trader, it can be very difficult to raise capital to expand the business.

Banks, in particular, often prefer the greater accounting transparency that comes with a limited company compared with the more private nature of a sole trader. Because of this and the perceived greater risks often involved, banks may be unwilling to lend large sums to sole traders. Whether they do advance loans, the terms offered may not be as generous as those provided to a limited company.

Most other forms of long-term finance will not be available to sole traders. Unlike a company, they cannot issue shares or other securities in exchange for investment. Some government schemes may also not be accessible to those who’ve set up as a sole trader.

6 No one to share ideas with

Being a sole trader doesn’t stop you from having employees. However, ultimately all the important decisions will fall on you and there’s no one to share accountability with. This lonely existence, where one unwise decision that you alone make may prove disastrous, doesn’t suit everyone. While you give up an element of control by going into business with others, you gain the benefit of your collective ideas, experience and enthusiasm.

Many people work better sharing responsibility with others in either a partnership or a limited company, making use of your different skills. You might be a great designer, for example, but not feel comfortable doing the accounts. It might be that none of you alone would feel comfortable coming up with ideas to promote the business, but together you can brainstorm, refine and implement an effective strategy.

7 Lack of business continuity

Problems can arise when a sole trader retires or dies. They, or their family, might want to be able to sell the business that so much work has gone into building up, but that’s not easy when it’s been operated as a sole trader.

Something else that needs to be considered is what happens if the sole trader is sick or has an accident and therefore can’t work. As well as making it difficult to seek new income opportunities, a sole trader working alone will be faced with the question of how to fulfil existing contracts.

8 Poor work-life balance

For the majority of sole traders who do not employ anyone, the work all falls on one person. It can therefore prove difficult to take holidays or even sick leave. Many sole traders work long hours to build the business and avoid disappointing clients. The business can absorb an ever-increasing amount of time and energy, leaving little for family or a social life.

Having said all that, the key problem here is all the work falling on one person. While that particularly affects sole traders, it will also impact a limited company which is owned and run by a single individual. But while a limited company owner can invite someone else in as a director, the sole trader cannot do so without first adopting a new business structure.

 

To see the other side of the coin, read our summary of the advantages of operating as a sole trader. As another potential structure for your business, you may also be interested in the advantages that setting up your business as a limited company can provide.

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