The sole trader: Everything a business founder should know

Many employees dream of becoming their own boss and it’s easy to get started. All you need is a promising business idea, good preparation, and confidence in your own abilities. It’s no wonder then that around 60% of businesses in the UK were sole traders in 2018. You can become a sole trader without having secured any large seed capital from influential business partners. But what prerequisites need to be met, what formalities must be observed, what are your tax obligations, and what risks should you be aware of in advance?

As a sole trader, anyone who wants to become self-employed in the UK can set up their own business. As the name suggests, the prerequisite is that it is founded and managed by an individual. However, you can hire employees right from the start, or as your business needs and success grows.

The sole trader is a business legal form, that describes a business which is managed by a single person. Compared to a limited company, registration as a sole trader with the HMRC is even easier. One does not require any minimum share capital to get started as is the case for private limited companies in the UK. This makes it much easier for entrepreneurs to move into self-employment.

For more information on how to get started as a sole trader, see our guide on starting your business as a sole proprietor.

What distinguishes the sole trader from other business forms? Just like limited companies and partnerships, sole proprietors are bound by certain requirements - from rules on tax treatment to business registration. Once you understand the rights and obligations of a sole trader, you can decide whether or not it is the right choice for your business idea. If you have any doubts, you can seek the help of professional consultants.

First things first, the company must be given a name. Small businesses and freelancers often use their own names as their business names when they register with the HMRC, clearly describing the industry or specific service they provide. If you prefer to choose a different name other than your own, you may want to register your company name with Companies House to ensure nobody else has taken it and protect it in the future. If the name is already taken, you need to select a different one. We recommend selecting an industry-typical name, which makes it obvious to potential customers and business partners what goods and services you’re providing.

The management usually connotes the owner or founder of the company. You can refer yourself as owner, manager or founder, but it’s best to steer clear of giving yourself an official title that is used in other common business structures such as “director”.

The owner has the possibility to transfer the conduct of business by commercial powers to another person or to share management responsibilities. This makes sense if the company continues to grow and becomes difficult to manage by a single person.

There is no required start-up capital when you register as a sole trader. However, it is not possible to start a business without some kind of financial reserve, because depending on the company, machines, tools or basic office equipment will need to be purchased. It may also take some time for your business to generate profits. During this time, running costs (insurance, office rental, etc.) must be covered.

Liability is the one major weakness of the sole trader structure. The owner is fully liable with both their company and private assets. This includes any property they own, vehicles, and other valuables. All this can be pledged up to the value limit set out in the law if the company becomes insolvent.

It is, therefore, important to be aware of the risks before setting up the business. If there is a high entrepreneurial risk, a structure like a limited company may be more suitable. If you still prefer to do business as a sole proprietor, it may be a good idea to protect yourself from insolvency by taking out additional insurance.

Every sole trader is required to provide the HMRC with an overview of the income and expenditure at the end of the financial year (usually April), which serves as the basis for the future tax treatment of the company. For small businesses and freelancers, simple record-keeping is sufficient. This is included in your annual tax return. In contrast, larger companies are required to keep double-entry accounting records.

After registering your business with the HMRC, you will be required to pay taxes on your earnings through a regular tax return. You will pay Income Tax and National Insurance Contributions. Therefore, it’s important to keep a record of all business income and any outgoings or expenses. As a sole trader, you can just pay yourself from the money you make. However, if you’re planning to grow the business over time it may be worth setting some money aside to reinvest in your company.

Dissolving the sole proprietor status is as quick as it is to set up. For this purpose, business assets have to be transferred to private assets, i.e. transferred from the company to the private account. You will need to inform HMRC of your change in status, for example, you may have accepted employment or changed the legal structure of your business to a limited company. In any case, you need to notify HMRC of these changes. You can also be employed and self-employed at the same time.

• Foundation: Only possible by an individual
• Company name: Name of the founder or other company name
• Seed capital: Not required by law
• Liability: Unlimited (with both business and private assets)
• Registrations: HMRC and Companies House if registering for a business name
• Accounting requirements: Single-entry bookkeeping is sufficient
• Tax obligations: Self-employment filed through an individual tax return
• Dissolution: Inform HMRC of any changes

The biggest advantage of setting up as a sole proprietor is that it’s very easy and no start-up capital is needed. In addition, there are relatively small bureaucratic hurdles. Sole traders only have to register with HMRC, which is free of charge. Aside from office space or machinery, you may need for your business, becoming self-employed as a sole trader can incur very small set-up costs.

However, all these advantages come with a major disadvantage: unlimited liability. This means that the owner is liable with all their assets, including private ones. For this reason, a founder should carefully consider whether their business idea involves increased entrepreneurial risk. If that is the case, opting for a company with limited liability may be preferable.

Please note the legal disclaimer relating to this article