What Is a Sole Proprietorship? Definition, Pros and Cons (2024 Guide)

Most entrepreneurs in the UK opt to create sole proprietorship also known as sole trader business structures because of the simplicity of setup and management. The sole proprietorship is the most common business structure in the UK, comprising 3.1 million sole traderships, which is 56% of the total companies in the UK.

This business structure enjoys many advantages, but it also has some drawbacks. You will enjoy the freedom that comes with self-employment, operating your business on your own terms. You will have no shareholder, a partner to share profit with, or a board of directors.

Although you will enjoy the flexibility of this business structure, you will also carry all its burdens, like losses. This guide will explore the definition, characteristics, pros, and cons of setting up a sole proprietorship in the UK.

Definition of Sole Proprietorship?

A sole proprietorship is a business structure you don't need to incorporate with Companies House. It is managed by one and owned by one person. The owner and the business are not legally separate, which means you don't need a separate bank account for your business. Your business assets and your personal assets are deemed the same. As a result, you'll have personal liability if your company enters into debt.

This business form is also called proprietorship, sole trader, or individual entrepreneurship.

The business owner or the trader operates the proprietorship using their legal name. They may also use another name by registering the trade name with their local authority.

A sole proprietorship business is the most accessible and least expensive business you can start. It's commonly used by small businesses, freelancers, tutors, consultants, virtual assistants, etc. A sole trader starts and ends when the owner decides or ends upon their death.

If your venture grows stable, you can transform your sole trader into a more complex business structure, like a limited company.

Characteristics of Sole Proprietorship

A sole trader has characteristics, such as a lack of formal incorporation, making it a convenient, low-cost business option. However, this simplicity also increases the owner's legal liability, rendering this option unattractive for some businesses.

The characteristics of sole proprietorship include:

1. Total control: A sole trader is responsible for the company's business decisions. They do not get to choose a board or any other member to be part of the business. Sole traders are independently responsible to the companies, and 100% own their enterprises.
2. Personal liability: The owners of sole trader businesses have legal responsibility for the company's obligations. The owner also remains personally liable if someone sues the business. The owner may need to use their personal property as security to access the loan.
3. No separation: Since the business and the owner are one, you should file your personal income tax. You can also choose your individual bank for business transactions.
4. More straightforward requirements: sole traders don't form their company with the Companies House. They can file a DBA if they wish to use a different name for business. They have no reporting requirements like other business structures. They only file taxes every year.

What Are the Demands for Registering a Sole Proprietorship Company?

The following are the requirements that you need to meet to register your sole proprietorship in the United Kingdom:

There are UK requirements that you should meet to register as self-employed. First, you must inform the HMRC that you will be paying tax through Self-Assessment as a self-employed individual. The registration is simple, and you can do it online, but meeting the due dates is essential. You must register before the 5th of October in the second tax year since the commencement of your business.

UK legislation states that a sole trader must pay National Insurance (NI) if their business's annual income exceeds £6,365. This payment is mandatory under sole trader law, and you can access benefits such as the State Pension. You will pay either NI Class 2 or Class 4 based on how much money you make. After subtracting all costs, you'll find the profit or the amount owed in your last figure.

Having an NI Number to register a sole trader business in the UK and for the National Insurance Contributions is mandatory. UK residents are given their NI number before age 16, while the foreigners will obtain their number printed on their residence permit.

Registering a Sole Proprietorship Business in the UK

To register a sole trader company, you need to verify your legal status as a business owner. If you are an alien planning to register your sole trader company in the UK, you might need a legal visa and resident permit to operate a business there. Once you've completed all the legal requisites and all the documents, you can proceed with your registration procedure.

1. Name and address: Sole traders mostly conduct business under their own names but must submit an official business address in the United Kingdom for tax and registration purposes.
2. Register with HMRC: To start a sole trader business in the UK, you must notify HMRC and follow all the rules and regulations regarding this business structure.
3. Bank account: Sole traders must have a business account exclusively for the sole trader business; all financial transactions will occur, and records will be stored here.
4. Certificate of incorporation: Upon successful registration, the Certificates of Incorporation will be issued, and the date of incorporation and registration number will be indicated.

Since the UK sole trader is not legally obligated to declare any information to the Company House, market competitors will only have a limited glimpse into your business information. This adds privacy to your sole trader in the UK.

Pros and Cons of Sole Proprietorship

Opening a sole proprietorship comes with benefits and drawbacks. Let's explore its pros and cons:

Pros of Sole Proprietorship

Here are the advantages of sole proprietorship.

1. An easy and inexpensive way to start a company

The process of sole proprietorship registration also varies by jurisdiction but is relatively easy and cost-efficient compared to forming a partnership or corporation.

Sole traders do not have much paperwork to submit to the local authorities. Compared to other business structures, they can receive permits to start immediately.

Start-up costs are also low, which aligns with the government strategies that seek to promote entrepreneurial activities by removing impediments associated with starting up businesses and boosting the economy.

2. Full control

Business owners oversee all aspects of the business, from manufacturing to marketing to financial aspects to employee affairs. Owners find this kind of independence very appealing as the business's success implies success for the owner.

Proprietors only need to be good enough in the various aspects of their business that they manage to be successful.

As a proprietor, you may have workers acting on behalf of the business, but you are personally liable for all the business's actions and decisions.

3. Few federal rules and laws

No significant legal requirements from the government directly address the sole proprietors' business. They are expected to keep account books, file tax returns, pay taxes, and maintain personal income.

The record-keeping and filing taxes for a sole trader are not much different from individual taxes. However, the proprietors may use other software or seek accountants to undertake these processes because of the time required to complete these processes.

However, large and public limited companies have more extensive regulations, such as financial reporting regulations, that do not apply to sole trader businesses.

4. No corporate income taxes

Unlike the more prominent companies, sole proprietorships are exempted from corporate income taxes. But in this case, the owner only needs to pay the personal income tax.

Other taxes the owner needs to pay include the self-employed taxes and national insurance contributions. This is accomplished by preparing the self-assessment tax return with HMRC.

5. Pass-through business profit.

In a sole trader, there is no separation of the business entity and the owner; thus, the owner is entitled to all the business's profits. The owner takes all the profits and pays only one tax: individual taxation.

Business owners must make tax payments on their income at least once yearly with a tax return, depending on the country's laws. You may make payments more often, like quarterly.

Paying taxes regularly keeps the levels reasonable so that you do not find it difficult to pay and avoid incurring penalties.

5. Less paperwork

Some business owners do not like to deal with more paperwork, so some choose to operate under a sole trader rather than incorporate it. Incorporation calls for yearly filings, which add to the pile of documents, and hiring a bookkeeper familiar with corporate and securities laws, which is not cheap.

Additionally, less paperwork means more time for the best planning and, thus, less possibility of future troubles.

6. Straight dissolution process

Terminating the business is easy when you decide to do so. There are no complicated procedures to follow, especially regarding legal matters, as might be the case with a significant corporate way of doing business.

7. Personalised customer service

The owners of sole proprietorships can deliver one-on-one services, allowing many customers to trust the businesses.

Unlike large firms with standard customer relations offices, most sole traders personally deal with their consumers. They offer services according to individual consumers' requirements, solve specific problems, and offer personal care.

This active strategy appeals to the customer's immediate needs, helps them build confidence in the business, and gives them reasons to return to the company and bring others with them.

Cons of Sole Proprietorship

Here are disadvantages of Sole Proprietorship

1. Unlimited liability

One of the significant disadvantages of a sole trader is that the proprietor bears an unlimited risk for the business.

This is because, in legal terms, the owner and the business are one, and the owner is liable for any business debts or any legal case that may arise. As a result, the creditors have the right to seize personal assets for business-related debts, such as savings, vehicles, or property.

To mitigate this exposure, the sole trader may require legal protection by buying liability insurance and enhancing ways of protecting personal property.

2. Challenging to raise capital

Owners of sole trader businesses use their own money. These businesses enjoy very little credit, making it difficult to find finance. They cannot issue shares and thus need capital, which can be expensive as they look for ways of sourcing funds before the business starts generating the money.

Effective management of current assets and liabilities is crucial since you will incur costs in the initial stages of operations. In contrast, equipment has to be either purchased or leased. Sometimes, the availability of funds may be inadequate, and in such cases, the enterprise's owners may need to exercise a lot of capital restraint in their fixed asset investments.

A well-laid-down business plan is essential for proprietors to gauge the amount of capital required for start-up, the sustenance of the business, and its expansion capital.

3. Less financial control

One of the challenges that sole traders face while operating their business is poor bookkeeping and inadequate records of their business's financial transactions.

The lack of formal reporting and internal controls makes controlling expenses, reviewing cash flows, and making sound financial decisions difficult. The absence of supervision in the affairs of this business leads to mistakes, expensiveness, and poor bookkeeping, which may harm the business's profitability and sustainability.

To avoid these risks, sole traders must establish effective accounting procedures, consult with financial advisors, and monitor the financial results.

4. Limited management skills

Sole proprietors manage all the significant functions of a business organisation: operational, marketing, financial, and personnel.

However, not all sole traders can possess all the skills and expertise that would enable them to manage all aspects of the business. A lack of practical management skills in an organisation can slow development. This may negatively affect the organisation, and cause some problems.

To address these issues, sole traders might have to spend money on training, finding a coach or a mentor, or delegating tasks.

5. Lack of economies of scale

One clear disadvantage of the sole trader business is the inability to achieve economies of scale due to their small size and little capital.

Essential business costs such as raw materials or supplies may also be expensive due to lower bargaining power than organisations with large orders. It can also make it challenging to compete against larger organisations and limit their capacity for growth and consistent profitability.

Therefore, sole traders should aim at specific markets, differentiate their products or services, and conduct business more efficiently by applying technology to reduce costs as much as possible.

Business owners must recognise these challenges, since addressing them will help enhance the business's ability to expand and improve the chances of achieving entrepreneurial objectives.

Can I change from a Sole Proprietorship to a Limited Company?

A sole trader may transition to a limited company when earning more revenue, usually from £30000 to £40000 per annum. At this level, possible tax benefits of £500 to £960 a year can offset the extra expenses of operating a company.

The extra expenses associated with operating a limited company, all of which are tax-deductible, include:

1. Having a non-residential registered office address costs about £40 a year.
2. Annual confirmation statement: a fee of £34 for each year.
3. The cost of an accountant's service begins from £250 annually for preparing a company's annual accounts or tax returns, from £50 to £250 monthly for the bookkeeping and accounting.

Form Your Company with Incorpuk Today

At Incorpuk, we will help you through the company formation process and file your confirmation statements to help your business stay compliant. Whether you're a UK resident or a non-UK resident, our team is ready to provide guidance and help you establish your company in the UK. Contact us here today.

Final Thought

The sole trader business is suitable for self-employed persons managing a small business, like consultants and freelancers. It is most appropriate for relatively low-risk businesses with promising revenue. You may start as hobbies or part-time activity and later become a full-time business.

A sole proprietorship has advantages like the ease of entering the entrepreneurial world. It requires little paperwork, inexpensive start-up costs, and control of all business aspects, making it a good idea to run a personal business. However, it is more important to know the precautions that go with it to avoid having issues in the future. Kindly contact one of our Incorpuk experts here if you have any question on sole proprietorship.