What are the risks of being a sole trader? | Top 5 Risks (2024)

One of the benefits of working as a sole trader is the simplicity of setting up your new business. It is a more straightforward structure, giving you sole responsible for the business, and ultimately allowing you full control.

As a sole trader, you can follow your visions and dreams, and best of all, you are entitled to keep all the profits once tax has been deducted.

But, there are advantages and disadvantages to working as a sole trader, and being aware of the specific risks related to this business structure is the best way to mitigate their consequences.

Why are sole traders high-risk?

Sole traders are considered high-risk for several reasons.

One risk relates to the ease of setting up the sole-trader business, generating another concern about businesses that sometimes operate without so much as even a skeleton business plan and quite often without any reserves either.

Another risk relating to sole traders, is that many see the money that is coming into their business (hopefully through a business bank account and not a personal one), as “their own”, without accounting for the fact that at least 25% of their income should be put aside to pay their tax and national insurance.

Another high-risk trait of being a sole trader is work overload. Working alone as a “sole trader”, you need to wear several hats.

In one you are generating business, in another doing the work you generate, in the other doing the accounts to keep track of the money coming in and going out of your business.

One other risk is this – unless you hire an accountant, you need to be 100% certain that you’re up to speed with tax law, such as what is and what is not an allowable expense.

In other words, are your accounts up to scrutiny? Will you even find the time to put on the hat you wear to do your accounts to meet the 31 January self-assessment tax return deadline each year? And so on …

Top 5 risks sole traders may encounter

There are risks involved in running a business no matter which structure you choose – freelance, self-employed, sole trader, contractor, limited company, limited liability partnership – but there are benefits to be had too.

It is important to learn about the risks so that you can try to avoid them:

• Risk of sole responsibility: with personal liability, you are responsible for any losses the business may incur (unlimited liability).
• Risk of paying more taxes:there are fewer tax planning opportunities; limited company businesses pay corporation tax, whereas sole traders play income tax plus national insurance on their earnings.
• Risk to work-life balance:although sole traders can employ people, many sole traders find they work longer hours.
• Risk of not being eligible to tender for jobs/risk to professional credibility:particularly in the public sector, tenders are not open to sole traders. Some feel that sole proprietors aren’t as serious as limited companies.
• Risk to growth:even if your sole trader business is doing well, lenders are more wary of sole traders.

Why aren’t a sole trader’s personal assets protected?

The reason sole trader’s personal assets aren’t protected is that in law, the business hasunlimited liability, which means there is no legal distinction between you, personal circ*mstances, and the business.

When you operate your business as a sole trader, therefore, its liabilities and debts are your liabilities and debts.

This means that, should the business fail and be in debt, not only will your income be affected, but you are liable to pay any money owed by the business from your assets, no matter that they are not even connected to the business.

And, because you are running a business as a sole trader with unlimited liability, this means that you could even lose your home if you own it, and, potentially, face bankruptcy.

In contrast, as alimited liabilityyou are a separate legal entity from your business, so yes, you may stand to lose whatever money and assets you put into the business, but if it gets into debt your personal assets remain protected as it is the business that is liable for any debt.

Risks of being a sole trader- explained

Now let’s take a closer look at the risks associated with being a sole trader and the worst case scenario:

Risk of sole responsibility

With personal liability, you are responsible for any losses the business may incur (unlimited liability).

Therefore if you business fails it could affect your personal assets. Debt collectors can access your savings, property, cars, and more in order to see a debt repaid.

Risk of paying more in taxes

Although a sole trader is entitled to keep all the profits from their business once income tax and national insurance have been deducted, there are fewer opportunities for tax planning open to them compared with a limited company structure.

For example, limited companies pay corporation tax on profits from the business (typically lower than income tax and coming with a few tax relief options if the business is eligible).

Also, limited company owners can award themselves lower salaries below the income tax threshold and can minimise tax by paying themselves dividends below the tax threshold.

Risk to work-life balance

Although sole traders can employ people, many operate alone, trying to build up their business, working long hours and not taking a holiday or even a weekend off to try to meet their clients’ expectations.

Risk of not being eligible to tender for jobs/risk to professional credibility:

Particularly in the public sector, public procurement tenders often will not accept a bid from a sole trader for a high-value commission.

This is due to “a legal requirement that all companies hold Employer’s (Compulsory) Liability Insurance of £5 million as a minimum.”

This can mean that sole traders miss out on high value jobs.

While they can be more successful with lower value bids, these tend to be less lucrative and more labour-intensive, hence there may be a further risk of taking on a loss-making job and working longer and longer hours.

Then there is the albeit unfair assumption that a sole proprietor is not as serious a business as their limited company counterpart.

Risk to growth

Say your business is doing well and your plan is to expand, purchase new equipment and relocate to larger premises.

Too often, sole traders run a distinct risk of not achieving their finance objectives due to lenders’ reluctance and banks’ wariness.

This is due to the perceived risk that lending to a business that has this “simplified” structure, notoriously less strictly controlled in accounting terms, will mean that it does not have the credentials and does not have to file accounts to Companies House.

How can Cloudco help you operate as a sole trader efficiently?

Cloudco Accounting Group provides affordable, reliable accounting services that benefit any business whatever legal structure it has.

Cloudco provides businesses instant access to our accounting software which – sinceallbusinesses must be up and ready to operate within HMRC’s Making Tax Digital (MTD) legislation by April 2024 – makes very good sense.

For sole traders, Cloudco can look after your accounts and lift the administrative burden with focus on running the business compliantly, profitably and efficiently.

The main thing we ensure is that sole traders avoid debt, maximise profits, and always file, on time, accurate, up-to-scrutiny tax returns.

For sole trading businesses, Cloudco provides basic accounting services to a gold-standard level, using either online accounting software or in-person.

But Cloudco can offer many, many services to businesses, including VAT registration and accounting, payroll services, business advice (including guidance on writing a business plan), tax planning, and much more besides.

Ourqualified accountantscan guide, advise, assist – help to mitigate the risk to being a sole trader – by helping any business owner navigate the world of commerce.

If you are thinking about changing your sole trader business structure to a limited company, we can help you with that too.

Our business is to ensure that your business is compliant, and that it is given every chance to succeed and prosper, no matter what legal structure you choose to operate under.

Conclusion

There are risks associated with working as a sole trader — like everything there are advantages and disadvantages to this business structure.

A distinct advantage of working as a sole trader is the simplicity of setting up the business and its straightforward structure.

The distinct disadvantages relate to the personal liability nature of the business legal structure, the tax implications, the depleted options for loans and finance, and the perception that sole traders are less reliable or serious than their limited company counterparts.

There are pros and cons involved in running a business no matter which structure you choose – freelance, sole trader, contractor, limited company, limited liability partnership – but there are benefits to be had too.

Cloudco are ready to help any company, all businesses, no matter what legal structure, to mitigate the risks of non-compliance, reap the benefits, enjoy the opportunities, and avoid the risks that come with running a business. Contact us today!