One of the first decisions you need to make when setting up a business is choosing the right business structure. In this article, we answer the question “What is a sole proprietorship?” and look at the advantages and disadvantages of using this business structure.
Before choosing any business structure, it’s important to get tax and legal advice relevant to your specific needs and the circumstances of your business. So, while this article aims to inform you about the basics of what a sole proprietorship is, it definitely doesn’t constitute legal advice! If you want to learn more about sole proprietorships and other business structures, head over to the Gov.uk website.
What Is a Sole Proprietorship?
A sole proprietorship is a business owned and run by one person who retains all its profits. They are also personally liable for all of the debts and losses of the business. Sole proprietorships are the most popular business structure in the UK – in 2020, sole proprietorships accounted for 59% of the UK private sector.
This is because it’s is the simplest type of business to set up and maintain. Even though they are a relatively simple business structure, there are a few general issues to be aware of when it comes to setting up a sole proprietorship.
A sole proprietor can operate under their own name or a business name, which must appear on all paperwork relating to the business. If you create a business name, you can’t include any terms that suggest the business is something other than a sole proprietorship. These terms include things like “limited”, “limited liability partnership”, “Ltd”, “LLP”, “public limited company”, and “plc”.
Your business name also can’t be the same as an existing trademark or business name. It can’t be offensive or a name that contains a sensitive word. You can find out more about choosing your business’ name here.
Regulatory and Tax Obligations as a Sole Proprietor
You don’t need to register your business as a sole proprietor. However, you must tell HMRC that you will be paying tax via Self Assessment. As a sole proprietor, you’ll also need to keep records of the following:
- All sales, income, and expenses
- VAT (if you’re VAT registered) and PAYE (if you employ anyone)
- Personal income
Records of these can be kept as receipts, bank statements, or invoices. These documents will help you to prepare your tax return and you must send them to HMRC if they request to see them. In a sole proprietorship, the owner is usually the one and only employee. You can employ other people as a sole proprietor, but you’ll then need to also pay income tax and National Insurance Contributions. If your turnover exceeds £85,000 a year, you’ll also need to register for VAT.
In the UK, the terms sole proprietorship and sole trader are often used interchangeably. There is also a crossover between the terms sole proprietorship and self-employed. While sole proprietor and sole trader refer to the type of business structure, self-employed refers to the tax status.
All sole proprietors are self-employed, but you can be self-employed and be in a partnership or a limited liability company.
Sole Proprietorship Advantages and Disadvantages
Like any business structure, it’s important to understand the advantages and disadvantages of a sole proprietorship before choosing whether it’s the right business structure for your circumstances.
Sole Proprietorship Advantages
There are several advantages to setting up a sole proprietorship. The setup and running costs are low and the ongoing administration is minimal. The tax obligations are straightforward, requiring only fairly basic accounting and record-keeping practices.
As a sole proprietor, you have complete control of your business. You don’t have to consult a partner or shareholders which means you can make business decisions quickly in response to your clients’ needs.
As a sole proprietor, you also get to keep any profits the business makes. In contrast to a company whose accounts and director information is accessible via Companies House, the details and records for a sole proprietor are kept private, accessible only by HMRC.
To summarise, the advantages of a sole proprietorship are:
- You have complete control over the business and keep all of its profits
- The barriers to entry are low – there are minimal costs and little paperwork involved
- The running costs and regulatory obligations are also minimal
- Your business’ financial information is not publicly accessible
Sole Proprietorship Disadvantages
Like any business structure, there are also some disadvantages to operating a sole proprietorship. The main one is that as a sole proprietor, all the debts and liabilities of the business are your responsibility. There is no separation between you and the business, meaning the authorities can seize your personal assets to cover outstanding debts.
The control aspect of your business can also be a double-edged sword. While some people enjoy having complete control over the business, others may find it challenging not having someone else to give a second opinion or help make difficult business decisions.
It can also be difficult to secure additional capital to grow your business as a sole proprietor. Given the personal liability of sole proprietors, banks may perceive them as higher-risk borrowers. As a result, they may be less inclined to provide business loans to them. Once you’re earning above a certain threshold, however, it may make more sense tax-wise to move to a limited company structure.
So, the main disadvantages of a sole proprietorship are:
- You are wholly and personally liable for the debts and obligations of the business
- It can be difficult running a business without anyone to run ideas by or provide a second opinion
- Banks may be less likely to provide loans to sole proprietors
Sole Proprietorship Examples
A sole proprietorship is a popular business structure for tradespeople, freelancers, and consultants in a variety of fields. For example, a personal trainer could operate a sole proprietorship as the owner and only employee. They might choose to trade under a business name, or under their own name.
After registering for Self Assessment, they could issue invoices under this name to their clients. They need to keep records of their invoices and payments. When it’s time to pay their taxes, they would then file a Self Assessment tax return and pay tax on their profits.
Sole Proprietorship vs LLC
If there are large amounts of capital or potential profits involved in your business, you might want to consider registering as a limited liability company (LLC). In contrast to a sole proprietorship, an LLC has a legal identity separate from its owners (shareholders) and managers (directors). Even when there is only one person who is both an owner and manager of an LLC, the personal liability of that person is separate from the company, protecting their personal assets.
There are also tax efficiencies with LLCs, as the tax rates for corporations are generally more favourable than for individuals. The trade-off is that setting up and running an LLC is much more complex and potentially more expensive than a sole proprietorship. This isn’t the kind of business model for a freelancer!
Partnership vs Sole Proprietorship
Like a sole proprietorship, a partnership is a relatively simple business structure with low barriers to entry, minimal running costs, and straightforward accounting and tax requirements. The main difference is that the financial and decision-making responsibility is shared in a partnership.
The partners share the liabilities (and profits!) and there are more people involved in the running of the business. So, if you’ve been discussing a business idea with someone and are happy to share the ownership and decision-making, then you might choose a partnership over a sole proprietorship.
You can now probably see why a sole proprietorship is a particularly attractive business structure for freelancers. But it’s important to consider the advantages and disadvantages of a sole proprietorship when deciding whether it’s right for your business. If you’re still unsure, you can also check out our articles on other business structures in the UK here.