Sole traders are the most common form of a business organization throughout the world because of a range of advantages.
This is the simplest way to set up a business organization. As a sole trader is self-employed, he or she is fully responsible for all debts and obligations related to the business. Creditors with a claim against a sole trader would normally have a right against all of his or her assets, whether business or personal – this is known as unlimited liability.
As a sole trader, the owner of the business performs all the functions required for the successful operation of the business such as securing the capital, establishing and operating the business on daily basis, assuming all risks, taking all profits but also facing all losses, and paying all TAXes.
Let’s take a look at advantages and disadvantages of being a sole trader.
Advantages of being a sole trader
Advantages of sole traders include:
1. Being your own boss. Sole traders are self-employed which means that they do not take orders or directions from anyone. They have total decision-making power and complete control over their business without interference. They do not answer to anybody else because they are owners in direct control of decision-making. Hence, all decisions are made very quickly as sole traders do not need to seek approval from a supervising manager. They make all of the decisions, have flexibility as to dictate their own working days and hours, and enjoy high self-esteem from being successful or suffer greatly from failures. This flexibility allows sole traders to choose times, holidays and matters of working, and can provide more free time for family arrangements.
2. Few legal formalities. It is very quick and easy to set up a business as a sole trader. With greater freedom from bureaucratic regulations, the business can often be set up with a small amount of start-up capital. Administrative costs and start-up costs are much lower in comparison to starting other types of business organizations such as a private-limited company. A person setting up a house painting business only needs to buy a ladder, bucket, few brushes and a set of working clothes, hence minimal working capital is required to do so.
3. Keeping all the profit. The sole trader, as the only owner, receives all of any profit after TAX made by the business. It gives the individual a huge incentive to work very hard and to become successful in the future. There is also no need to disclose the amount of profit earned, therefore sole traders enjoy full privacy and confidentiality. Unlike other types of business organizations, sole traders do not have to make their financial records available to the public, except letting TAX authorities to scrutinize final accounts every year.
4. Personalized service. Sole traders can take into account individual customers’ needs to provide a personalized service to customers as a result of flexibility. This is something that larger firms might not be willing to offer due to the need to maintain certain level of profitability, or may not be able to do due to stiff procedures. When operating as a small business, sole traders have the time to get to know better all their customers and their preferences. Sole traders also offer family-like culture establishing close personal relationships with their employed customers and workers. Some customers prefer to directly deal with the owners and are prepared to pay higher price for this privilege. Because sole traders often start their business based on the interests or skills, they are very passionate to talk with others about their activities.
Despite of its popularity around the world, being a sole trader and running a business organization on your own has several disadvantages.
Disadvantages of being a sole trader
Disadvantages of sole traders include:
1. Unlimited liability. The owner of the business has unlimited liability for all the debts of the business, therefore risking losing personal wealth and belongings to pay for these debts. Having unlimited liability means that all of owner’s assets and even savings are potentially at risk. As an unincorporated business, there is no upper limit to the amount of debts that a sole trader is legally responsible for, if the business fails. In case of dispute, the owner will be sued personally.
2. High risks of failure. Sole traders are among small businesses that have very high rate of failure with many of them not even surviving the first year of operations. It is because they face huge threats from larger firms that have been more established on the market, therefore making it difficult for smaller businesses to attract customers, break-even and make profit. Sole traders face high workload and stress as they need to work very long hours to make a living from their business which is developing rather slowly in the initial stage. Owners need to perform all business functions (finance, marketing, human resource management and production) by themselves making it very unlikely that they are going to be equally effective in all of them.
3. Limited sources of finance. Trying to expand is also problematic due to the lack of sources of finance available to sole traders. They find it difficult to secure any funds beyond their personal savings, small personal loans from family members, or profits from the past years retained in the business. Even though they might be entitled to government support in the first year of existence as many governments tend to support business start-ups, sole traders often face difficulties in raising additional larger capital to expand the business at later stages. This is because of lack of sufficient collateral such as buildings or land.
4. Poor competitiveness. Sole traders are not able to exploit the benefits of large scale production, therefore cannot benefit from economies of scale. As they face higher cost of production, they are not able to compete with other businesses on price. The prices for products offered by sole traders will most likely be higher than other companies offering similar products, making the business less competitive against larger rivals in the industry. Many sole traders also have limited know-how, lack some of the essential business skills needed for managing a business, nor specialize in areas of the business that are interesting.
5. Lack of continuity. The running of a business will not continue, if the owner is not physically present. It may happen when a sole trader decides to discontinue the business operations, relocates to another country, becomes severely ill making him unable to work, retires or passes away. There will be lack of continuity in business organization in this absence of the owner, as the business does not have a separate legal status, hence the business will no longer exist. When the sole trader goes on long holidays, the business will also shut down for a certain period of time leading to loss of income.
