The simplest, quickest way to set up a business is to register as a 'sole trader' and manage everything yourself. A 'sole trader', otherwise known as a sole proprietor, is an individual who trades (buys and sells goods or services) alone. Sole traders are fully responsible for all of their business finances. This means that they personally own all profits, losses and debts.
Running a business as a sole trader is the oldest and most common way of running a business. Sole traders make up two thirds of the UK's private business sector.
Sole trader businesses tend to be small, local enterprises such as market stalls, small shops, B&Bs or small-scale services such as hairdressing, dog grooming or floristry.
Why be a sole trader?
There are a number of different ways of running a business. These different ways are referred to as 'ownership structures' and vary according to the distribution of ownership across the business - e.g. whether the business is owned by one or more persons, or whether the business is subject to limited or unlimited liability.
It pays to think carefully about what you want from your business before choosing an ownership structure. If you choose to become a sole trader, you are choosing to run your business alone.
There are a number of reasons why you might want to run a business alone. Perhaps you're keen to have full control over the whole process without the interference of others, or perhaps you want to keep the legal side of things as simple as possible. Whatever your reasons for registering as a sole trader, it pays to consider the disadvantages as well as the advantages. Some advantages and disadvantages of setting up as a sole trader include:
Ownership of profit and losses
Advantage: All of the profit your business makes is yours to use or save at your discretion. You don't have to share it, distribute it, or pay Capital Gains Tax on it. You simply have to record it for your annual return and pay Income Tax and National Insurance rates as you would on a normal wage.
Disadvantage: As well as claiming ownership over profit, as a sole trader you will be responsible for paying off any business debts and losses. This is because sole trader businesses are subject to unlimited liability, meaning that the trader herself/himself is legally the same entity as the business. Because of this, any losses or debts incurred by the business will put the owner's personal possessions - such as their house or anything of value - at risk of repossession.
Less paperwork and taxes
Advantage: Sole traders are not required to submit details of their accounts publicly. Registering with HMRC as a sole trader is simpler than registering partnerships and companies because there are fewer legal formalities, resulting in less paperwork. All you have to do is register as self employed and fill in an annual return. This is how HMRC works out how much National Insurance and Income Tax rates self-employed people have to pay. As a sole trader, you don't even have to register with Companies House - again saving a significant amount of paperwork, time and effort.
Disadvantage: Although sole traders don't have to pay Corporation Tax on top of Income Tax and National Insurance (as limited companies do), Corporation Tax rates are often lower than Income Tax rates. Whereas owners of limited companies can pay themselves in dividends to keep Income Tax as low as possible, sole traders do not have this option. Visit the HM Revenue and Customers website to find out more about Income Tax rates.
Full control over decisions
Advantage: When you come up with a simple yet effective business idea, it can be frustrating when other people interfere. Unlike in a company or partnership where decisions have to be mutually agreed by all parties, sole traders can do exactly what they want to do, without conference. Sole traders are free from time-wasting board meetings, obstructive disagreements and conflicting opinions. The advantage of working in this way is that business decisions can be made swiftly with no delay affecting the customers.
Disadvantages: Being alone gives you full control but it also gives you full responsibility. As a sole trader, all business decisions will lie in your hands - the bad ones as well as the good. These decisions will effectively be your livelihood - the difference between building a success or a failure - and must therefore be handled with the utmost care. Owners of companies and partnerships are often able to share this stress and reach critical decisions with each others' financial and intellectual support. Sole traders are in it alone. They must make the decisions alone and deal with the consequences alone. Of course, sole traders can seek support from family, friends and accountants, but the responsibility is still legally in the hands of the name registered.
Advantage: Being self employed means that you can decide when to work, how to work and where to work. You don't have to make the compromises employees often have to make, like booking annual leave, calling in sick or taking a designated lunch break every day. You are your own boss - if you want a day off, you don't have to ask anyone. You can choose your workload and you can choose your working hours- as long as you feel it's not affecting the success of your business.
Disadvantage: The fundamental rule of being a sole trader is that if you don't work, you don't earn. Running a business alone is not easy - it requires a lot of hard work and dedication to make a profit. This often means having to work beyond 'normal' working hours. Owning a businesses is totally different to working for one. You can't go home at 5pm and switch off; often there will be a million other jobs to be done that, if abandoned, could result in significant losses. When yours or your family's livelihood is in your hands, you'll probably think twice about taking the morning off for a lie-in.
Advantage: As a sole trader, your business is likely to be small. You will probably be working directly with your targeted market with a local network of support. Unlike some corporation Directors who hardly see the products they make, let alone the customers who buy them, sole traders can build strong relationships with their customers. A friendly, local, personal service is often seen as a USP (unique selling point).
Disadvantage: A close, personal service is all well and good when your business is small - but what about when you want to expand? With more work to do and added pressures, it's hard to be on the 'shop floor' all the time. You could lose valuable customers if your service deteriorates.
How to set up as a sole trader
Before you start business as a sole trader, you must inform HMRC that you are self-employed. HMRC needs you to register so that it can have access to information that will determine whether or not you need to pay Income Tax or National Insurance, and if so - how much.
You should try to register as soon as possible to ensure that your Self Assessment is ready by the end of the tax year (5 April). You can do this by filling in a Self Assessment registration form online at HMRC.
As well as Self Assessment, you may need to register for National Insurance.
In order to ensure that you do everything you need to do before starting, we've answered some of your most frequently asked questions about registering as a sole trader:
Sole trader FAQ
What information will I need to register for Self Assessment?
- Your National Insurance number (if you've never worked in the UK before you will have to apply for one).
- Your personal contact details and the details of your business if you've already started.
- If you have previously completed a Self Assessment return, you will find a 10 digit Unique Tax Taxpayer Reference number on any HMRC letters or forms regarding your tax return. You will need this number to register as self-employed.
- The date you started your business.
When is the deadline for Self Assessment?
HMRC requires you to register for Self Assessment before you fill out your first annual tax return so that they can set up the correct records and put you on the appropriate rates and deadlines. The tax year runs from the 6th of April to the 5th April the following year. You will need to register by:
- 5th October
Registering late will result in a 'failure to notify' penalty. It could also result in a blank in your records, which could effect your entitlement to National Insurance benefits such as your state pension. The only recognised reasons for late submission are:
- death of a partner or close relative
- serious illness.
Do I have to pay National Insurance as a sole trader?
As well as registering for Self Assessment, sole traders are required to pay Class 2 National Insurance on any earnings over a certain amount (this changes year on year). They are also required to pay Class 4 National Insurance on any profits over a certain amount (which also changes year on year). Visit the HM Revenue & Customers website to find out more about National Insurance rates.
If you are starting a business as a sole trader, you will need to start paying National Insurance as soon as you begin. The easiest way to pay your National Insurance contributions is through Direct Debit. Direct Debits are easy to set up - just fill in an application form and send it off to HMRC. Once it's set up, you don't have to do anything - Direct Debit pays automatically so you can sit back and let it happen without worrying about deadlines.
What happens if my earnings are too low for National Insurance?
If, as a sole trader, you earn less than the specified amount here, then you are exempt from National Insurance. However, you can't just sit back and do nothing - you must apply to HMRC for exemption.
Do I have to pay VAT as a sole trader?
You will only have to pay VAT if you expect your business to have an annual turnover of more than the VAT registration threshold. In this case, you will need to charge your customers VAT on the products or services they receive, then pass the amount onto HMRC. HMRC will inform you if you need to pay VAT after you have registered for Self Assessment.
Do I have to let HMRC know if I employ anyone?
Yes. If you pay anybody to help with your business, you will need to collect and pay employee income tax and National Insurance contributions. The easiest way to do this is to set up a PAYE (pay as you earn) system. Visit our guide to payroll to find out more.
Are there any registration fees?
No - only companies have to pay fees to Companies House. Registering to HMRC is completely free.
Top reasons why sole traders fail
Although setting up as a sole trader is widely believed to be the easiest way to start a business, it is by no stretch of the imagination 'easy'.
Legally, individuals working as sole traders are considered one and the same as their business. They inject their own money, receive all profits and answer to all losses and debts. When you're investing your own life-savings in a venture you hope will make enough money to pay the bills and support your life or your family, everything suddenly becomes a lot more personal.
Unlike with limited companies, where the company answers for any liabilities rather than the owners themselves, sole traders answer for their own mistakes. If a sole trader suffers a loss in business, their personal possessions - home, car or anything valuable, all become immediately vulnerable for repossession.
Business is a gamble - especially when you go it alone. Statistics show that around 50% of small businesses lose the gamble within the first 3 years of trade. So why do so many businesses fail?
Poor financial accounts
As a sole trader, keeping up to date with what you are spending and earning is absolutely essential. You need to know:
- Exactly where every penny of your money is going every month - are you wasting it on unnecessary items or services?
- Whether you are getting a good deal on essential business purchases - are you paying too much for base materials? Should you look to source from somewhere else?
- What your cash-flow forecasts are - it is important to have a cash-flow plan. A cash-flow plan can tell you if you need to borrow money and if so, how much, when and how you can repay the loan.
- Whether you could manage your spending better. Where is money going? Do you need to set a more realistic budget or prioritise certain costs? For instance - pot plants and scatter cushions may look nice in a beauty parlour but they're not as important as the heating bill.
- When are all of the tax and annual return deadlines for HMRC? Late fees can mount up very quickly to extraordinary amounts.
Poor business management
To become a successful sole trader, you need to be incredibly organised. Before you even start your business you will need to write up a detailed business and finance plan outlining everything you intend to do. To find out more about planning, take a look at our business and finance plan page.
You will need to make clever decisions based on quantitative data (financial forecasts), astute observations (based on market research) and common sense (not getting carried away with unfeasible ideas). Once you have as good an idea as possible about your market, your competition, your own finances and all the risks involved, you can begin to make good management decisions.
Businesses can fail on account of a single bad decision. This can be anything from leasing premises in the wrong place or sourcing products from an unreliable provider, to choosing a bad colour scheme or a terrible slogan. It's easy to get carried away with the aesthetics of business - branding, logo design, premises decoration etc., without taking into account realistic costs or budgeting. You could easily end up with a swanky looking shop, bar or hotel - with no customers.
Hiring an accountant to help start a sole trader
With a million tasks to complete with impeccable precision, it could pay to hire somebody to take care of your financial matters. Miscalculating your finances could lead you to complete ruin by producing inaccurate forecasts and causing you to spend money that you don't actually have. Sending inaccurate figures to HMRC could also lead to you having to pay more taxes than you really owe - without even knowing it. An accountant is fully trained to calculate and analyse your accounts accurately. As a sole trader starting out, it may be useful to hire an accountant to go over your business plan and check for any inconsistencies before you go ahead with any spending. This way, any detrimental mistakes can be caught in time.
An accountant can also handle your taxes and correspond with HMRC on your behalf. All you need to do is send of an agent authorisation form to HMRC when you register for Self Assessment.
To find out more about what an accountant is and how they work, visit our FAQ page.
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