What are the disadvantages of being a sole trader | Harper James (2024)

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

However, before launching any new venture, you must be wellversedin 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 employeesand 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 taxliability.
  • 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’tnecessarilymean that being a sole trader isn’t the right option for your business.

Tax efficiency depends very much on your circ*mstances 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.

What are the disadvantages of being a sole trader | Harper James (2024)

FAQs

What are the disadvantages of being a sole trader | Harper James? ›

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.

What are the disadvantages of a sole trader? ›

We'll now drill down into some of the potential drawbacks and so-called disadvantages of being a sole trader:
  • Unlimited liability. ...
  • Potential credibility issues. ...
  • Sole responsibility. ...
  • Fewer tax planning opportunities. ...
  • Barriers to finance. ...
  • Sale limitations.

What are the disadvantages of the sole proprietorship quizlet? ›

To conclude, unlimited liability, lack of continuity and money, limited management skills, and difficulty in hiring employees are the disadvantages of a sole proprietorship.

What are 3 disadvantages of a sole proprietorship which disadvantage is the most serious? ›

Three disadvantages of sole proprietorships are: Financial Liability – a lender could go after the owner for a bad debt. Legal Liability – a claimant could seize the owner's property to settle a judgment. Selling the Business – aside from assets, there is no company equity to transfer.

What are 5 disadvantages of a partnership? ›

On the other hand, the disadvantages of a business partnership include:
  • Potential liabilities.
  • A loss of autonomy.
  • Emotional issues.
  • Conflict and disagreements.
  • Future selling complications.
  • A lack of stability.
  • Higher taxes.
  • Splitting profits.
Jun 23, 2023

What is a disadvantage to a sole trader of having unlimited liability? ›

The most obvious disadvantage of unlimited liability is the risk to the owner's personal assets. There is no cap on the amount of money they could be liable for, so unforeseen circ*mstances, an unfortunate mistake, or poor business decisions could be financially devastating.

What are the 5 disadvantages of a business? ›

Disadvantages of owning a business
  • Financial risks. Depending on the type of business you're creating, you generally need to spend money to make money – and in the beginning, you may find you're spending more. ...
  • Stress & health issues. ...
  • Time commitment. ...
  • Numerous roles, whether you like it or not.
Nov 26, 2021

What are the risks of being a sole proprietor? ›

Unlimited personal liability

This is the greatest risk of a sole proprietorship. Without having a separate entity for your tax and legal issues, a court is likely to see all of your assets and liabilities, including personal, non-business-related items, as a single group.

What are the four primary disadvantages to the sole proprietorship? ›

It is hard for sole proprietors to raise capital. Sole proprietor firms have unlimited liability. Lack of finance and accounting control puts a business in a risky position. Sole proprietor firms have difficulty in retaining quality employees who can run a business in the long-term.

Which scenario is a disadvantage of sole proprietorships? ›

Being a sole proprietor means you are exposed to unlimited personal liability. You are personally liable for paying taxes, providing health insurance, and other legal costs or financial problems. In a sole proprietorship, you can be sued and have personal assets like your home or car seized to cover expenses.

What is a disadvantage of a corporation? ›

Disadvantages 1. A corporation is expensive to set up, usually between $500 and $2,500. 2. Corporate income is heavily taxed because it is subject to double taxation on its earnings.

What are the disadvantages of being a sole trader? ›

Cons
  • You'll be liable for any business debt. If your business gets into debt, you will be liable. ...
  • It will be much harder to raise finance. ...
  • You'll have less flexibility regarding tax. ...
  • It's harder to take a holiday. ...
  • You get to make all the important decisions. ...
  • You might appear less attractive to clients.
Feb 23, 2024

What is the biggest issue of sole proprietorship? ›

The most serious risk of a sole proprietor is unlimited personal liability for the business' debts. This means that if the business is unable to pay its debts, your house, assets, and bank accounts are in jeopardy. If you are married, your spouse's interest may also be at risk.

What are the pros and cons of sole trader vs Ltd company? ›

A sole trader pays income tax on all their business profits. If you have a particularly successful year, you'll pay more tax. A limited company has more flexibility. You can choose to draw a regular salary, which is taxed as normal income, but you can also earn dividends, which are taxed at a lower rate.

What are the advantages and disadvantages of a sole trader and a partnership? ›

However, because partnership profits or losses can be shared, some tax advantages may be gained by running your business as a partnership. Business decision-making and control: Sole traders have complete control over their business, while partnerships require collaboration between partners to make decisions.

Is sole trader a good business? ›

Advantages of Being a Sole Trader

You will pay your taxes through a self-assessment tax return. You keep all the profits the business makes — Since the company is yours and you operate under your name, you get to keep all profits after tax. In addition, the individual can retain personal ownership of business assets.

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