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As a startup owner, you likely know that you can structure your business venture through different entities. The most basic business entity is the sole trader. A sole trader describes a business where all of its assets and liabilities are inseparable from the business owners’ personal assets and liabilities. This article explained the advantages and benefits of operating or startup as a sole trader rather than other forms of business.
How Do I Become a Sole Trader?
You automatically become a sole trader if you engage in commercial activities that you do not structure through any other business entity, such as a:
- limited company;
- general partnership;
- limited liability partners; and
- limited partnership.
You cannot be a sole trader where you have a business partner. Instead, when two people work together on a business venture, absent any arrangements otherwise, they automatically have a general partnership.
What Are the Key Characteristics of a Sole Trader?
Below we consider some key characteristics of a sole trader business.
Limited Liability
The essential feature of running a business as a sole trader is that your business assets and liabilities are legally indistinguishable from your assets and liabilities. If you use your business sales to purchase a luxury car and later cannot pay a debt your business incurred, your creditors can come after your luxury car to settle your business debts.
As a result, if someone was injured during your trade, they could sue you for all your wealth regardless. This can happen even if you employ someone who causes the injury and is not directly responsible.
Of course, you can significantly limit this inherent risk by purchasing adequate insurance policies and conducting your business with appropriate care and skill. But, for these reasons, most sole traders operating in higher-risk industries or with sufficient assets will incorporate their business into a limited company. This creates a fence around your business’ liabilities and the business owner’s liabilities.
Tax
The other defining feature of a sole trader is that the business’ revenue is taxed as personal income. In other words, your business will pay tax based on how much money you bring in and the personal tax rates.
HMRC does allow a sole trader to claim business expenses from their taxable income, which can significantly offset your tax liability. However, compared to other business structures, you still may face a higher tax liability operating as a sole trader than you would be incorporating your business as a limited company.
Likewise, you can pay profits from a company as a dividend rather than a salary. Notably, dividends are taxed at a lower rate than salary income. In saying that, an accountant can advise on whether your business generates sufficient cash to benefit from the tax advantages for companies.
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What Are the Benefits of Operating as a Sole Trader?
Despite the inherent risk and higher tax liability generally associated with sole trader businesses, operating as a sole trader does have several benefits.
1. Administrative Ease
Running a business as a sole trader is far more administratively easy than running a company. If you incorporate a company and intend to be a senior manager, you must appoint yourself as a director. The law imposes numerous obligations on directors to run the company’s affairs lawfully and prudently. You and your company may also face fines and criminal liability if you do not abide by these obligations.
2. Lower Costs
For these reasons, companies usually require accountants and solicitors to advise the directors on their obligations. This cost, even at the lower end, often exceeds £1000 a year. Therefore, your business must generate sufficient sales and profits to justify incorporating the business into a company.
3. Avoiding Directors’ Duties
Likewise, even with professional advisers, your duties as a director often entail substantial time and effort, which you must spend even if it is not directly involved in how your business makes money. But, generally, if the business earns more than £50,000 a year, you should consider incorporating a company.
LegalVision’s Startup Manual is essential reading material for any startup founder looking to launch and grow a successful startup.
Key Takeaways
Sole traders are the default business entity for individuals who run a business alone. Sole traders do not have any limited liability, nor do they receive certain tax advantages. However, sole traders have far fewer obligations than business owners in other entities like limited companies.
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