Sole Trader or Partnership? Comparing Business Structures

Deciding whether to go it alone as a sole trader or join forces with others in a partnership is an essential consideration when launching a business.

To determine which structure is right for you it’s important to consider the advantages and disadvantages of both a sole trader or partnership.

In our sole trader versus partnership guide we look at each business structure and help you determine which path is best suited for your business.

We’ll discuss the benefits of setting up as a sole trader like simpler management and taxation and explore its drawbacks like personal liability exposure.

On the other hand we will examine partnerships from general partnerships to limited liability partnerships – highlighting their potential for shared resources and expertise while considering issues related to partnership liability.

Armed with the right knowledge you can confidently choose the best business structure for legal and financial reasons.

What are the benefits of setting up as a Sole Trader?

Setting up as a sole trader is often the simplest and most cost-effective way to start a business, making it an attractive option for many entrepreneurs.

Easier and a lower cost setup:

The process of registering as a sole trader is relatively straightforward and inexpensive compared to other business structures. In most cases you only need to register with HMRC.

Simplified and cheaper taxation process:

As a sole trader you are responsible for paying income tax on your profits through the submission of an individual self assessment tax return.

Sole traders pay income tax at rates depending on profit levels (20%, 40% or 45%). There is no corporation tax applicable for sole traders since they’re not incorporated entities like limited companies.

Partnerships require a partnership tax return and an individual tax return to declare your share of partnership profits or losses.

Finally there’s typically less work for an accountant to do if you are a sole trader so their bill should be lower in comparison to a partnership.

Total control over business decisions:

Becoming a sole trader allows you complete control over all aspects of your business operations without having to consult partners or shareholders before making decisions.

This autonomy can be particularly appealing if you have strong convictions about how best to run your enterprise or want full creative freedom when developing new products/services.

Fewer legal requirements & general reporting obligations

• No separate legal entity: As there is no distinction between you and your business there’s no need to create a separate legal entity or maintain separate financial records.
• Less paperwork: Sole traders don’t have to concern themselves with a partners issues or demands which can save time and reduce administrative burdens.

More potential for privacy:

Operating as a sole trader allows you to keep your personal information private since it is not necessary to disclose ownership details on public registers.

This can be particularly beneficial if you prefer maintaining a low profile or wish to protect your privacy for any reason.

Easier access to profits:

Sole traders have unrestricted access to their business profits allowing them the flexibility of using these funds however they see fit – whether that’s reinvesting in the company, paying off debts or enjoying personal expenses.

This differs from partnerships and limited companies where profit distribution may be subject to agreements with other stakeholders.

Drawbacks of setting up as a Sole Trader

The advantages of setting up as a sole trader are numerous and can provide an excellent platform for self employment but there are some potential drawbacks to be aware of.

Unlimited liability:

For some the most significant disadvantage of being a sole trader is that you have unlimited liability. This means that if your business incurs debts or faces legal issues typically you are personally responsible for covering these costs.

Your personal assets could be at risk in case your business fails or encounters financial difficulties.

Lack of financial support:

Sole traders often find it more challenging to secure loans and other forms of financing compared to partnerships or limited companies.

Banks may perceive them as higher risk borrowers due to their unlimited liability status and lack of separate legal identity from their businesses.

Investment opportunities:

Attracting investors can be made more difficult because there is no option for selling shares in a sole tradership business.

Potential loneliness and increased workload:

• Loneliness: As a sole trader you might feel isolated while running your business alone without any partners or employees who share responsibility for its success.
• Increase workload: You’ll likely need to handle all aspects of managing your enterprise on top of performing core tasks related directly to providing goods/services – including accounting/bookkeeping duties which can become time consuming if not outsourced properly.

Fewer tax planning opportunities compared to Partnerships:

Sole traders are subject to income tax on their business profits which may result in higher tax bills compared to partnerships or limited companies.

Partnerships can distribute profits among partners allowing for more flexible tax planning strategies.

Limited companies pay corporation tax often at a lower rate than income tax and provide opportunities for further tax savings through dividends and salaries through PAYE.

Benefits of setting up as a Partnership

Forming a partnership can bring many benefits like sharing of duties and responsibilities, access to more monetary resources and the potential for diverse knowledge and experience.

A partnership has to be made up of two or more people who share an agreed ownership and responsibility split.

Tax benefits:

In comparison to a sole trader partnerships can share profits which in some cases can reduce the income tax liability of some or all of the partners.

The partnership itself isn’t actually taxed it is the individual partners that taxed on the allocated income from the partnership.

Profits from a partnership are added to any other taxable income and taxed at the standard income tax rates.

The rates of tax used on partnership income are the same as sole traders at 20%, 40% or 45%.

Increased financial resources:

In addition to sharing responsibilities partnerships also allow for pooling financial resources together.

With more than one person contributing capital towards starting or growing the business there is often an increased capacity for investment in new projects or expansion opportunities compared to sole proprietors who must rely solely on their own personal finances.

Shared responsibilities:

By forming a partnership responsibilities can be allocated among the partners so that each may specialise in their areas of expertise.

This means that each partner can focus on their strengths while relying on others for support in areas where they may not be as skilled or experienced.

This division of labour can lead to greater efficiency and productivity within the business.

Networking opportunities:

• Broader connections: Each partner comes with their network connections which can help open doors for potential clients, suppliers, or other business opportunities.
• Increased credibility: Partnerships can often lend more credibility to a business in the eyes of potential clients and customers as they may perceive it as being more established and reliable than a sole proprietorship.

Potential for growth:

A partnership structure can allow businesses to grow at a faster rate due to the combined efforts of multiple individuals working towards common goals.

This growth potential is particularly beneficial for those looking to scale their operations quickly or enter new markets in the future.

Drawbacks of setting up as a Partnership

While there are several advantages to forming a partnership it is essential to be aware of the potential drawbacks before making your decision.

Shared liability and financial risk:

One significant disadvantage of partnerships is that partners share liability for the business’s debts and financial obligations.

This means that if one partner incurs debt or makes poor financial decisions, all partners may be held responsible for repaying those debts regardless of their individual involvement.

This also means each partner’s personal assets could potentially be at risk in case the business fails or faces legal issues.

Complexity of legal and tax requirements:

Compared to sole proprietors partnerships have more complex legal and tax requirements that can be time consuming and more costly to manage particularly for those without prior experience.

Partnerships must register their business with HMRC, maintain separate financial records from personal finances, file an annual partnership tax return alongside an individual self assessment tax return for each partner.

It’s usually recommended that draft a partnership agreement outlining each partner’s roles, responsibilities and profit share is drawn up by a solicitor.

Potential conflicts between partners:

In any relationship where multiple people work together towards common goals conflicts can arise and business partnerships are no exception.

A difference in opinion on a crucial business decision can lead to disagreements between partners. If you can’t find a way to resolve any issues promptly and amicably this might negatively impact the overall functioning and success of your business.

Limited decision making autonomy:

As opposed to sole proprietors who have complete control over their businesses’ operations and decision making processes partners in a partnership must often consult with one another before making critical choices about company direction or investments.

This shared responsibility can hinder growth or adaptability in rapidly changing markets.

Though collaboration can bring about creativity and innovation it may also impede decision making speed and agility in what could be a rapidly changing environment.

Limited lifespan:

A partnership’s existence is often tied to its partners’ involvement in the business meaning it could dissolve if one partner decides to leave or retire.

In such cases remaining partners would need to restructure the business or find new partners willing to take on the departing member’s share of responsibility which can be challenging depending on circumstances surrounding their departure.

Is it better to have a Sole Proprietorship or Partnership?

The choice between a sole proprietorship and partnership depends on your specific business needs, goals and circumstances.

We’ve explained many of the pros and cons of each option and now list the key elements to consider when selecting which structure is most appropriate for you.

Financial liability:

Sole traders are personally responsible for all debts incurred by their business meaning that if the company faces financial difficulties your personal assets could be at risk.

On the other hand partnerships allow partners to share liability based on their agreed contributions in the partnership agreement.

Taxation:

Sole traders and partners of partnerships pay income tax on their profits through self assessment.

The same income tax rates apply to both sole traders or a partners profits of 20%, 40% or 45%.

Because the profits or losses of a partnership can be shared some tax advantage may be gained by running your business as a partnership.

Business decision making and control:

Sole traders have complete control over their business making all decisions independently.

In contrast partnerships require collaboration between partners to make decisions which can be beneficial if you value shared expertise but may cause conflicts if there are disagreements.

If you would rather stay independent or just don’t want to risk ruining a personal relationship because of a business related issue then maybe a partnership isn’t the best option.

Business growth and flexibility:

While sole traders may find it easier to manage their businesses initially due to fewer legal requirements and less paperwork compared to a partnership structure.

This could limit growth opportunities in the long run as it can be harder for sole traders to attract investors or take on additional staff members without incorporating into a limited company.

Raising business capital:

• Sole traders often rely on personal savings or loans from friends/family when starting up; attracting external investment can be more challenging without offering shares in return.
• Partnerships offer greater flexibility when raising capital by allowing multiple partners with varying contributions (both financial and non financial) increasing chances of securing funding from external sources such as banks or investors.

Have you thought about a Limited Company instead?

Setting up a limited company is a third option to put on your business structure list which could be worth reviewing now or further down the line.

A limited company could give you better tax saving prospects and separate your business legally from you as an individual or partnership.

You can use our limited company guide to learn more about incorporating your business and what to expect from a tax and legal perspective.

Can an Accountant help me decide the best business structure?

Using an accountant to support you in your business structure decision can help you make a more educated choice.

A small business accountant can explain anything you aren’t totally clear about and give you advice on what is best from a tax point of view for your business and for you as an individual.

The contribution an accountant can make may prevent a regrettable mistake and help future proof your business financially and legally.