What is a sole trader?
A sole trader is a business organisation that is established, owned and controlled by one person. It is the most common form of business owing to the ease with which it can be established. Individuals who have an innovative idea or want the freedom to maintain a healthy work-life balance usually set out as sole traders. In fact, some large businesses were founded by a single person before expanding or changing their ownership structure.
Advantages of a sole trader
Easy to establish
A sole trader is the least-regulated business with limited regulatory requirements or minimal paperwork. It is easy and fast to establish because licences and permits are usually not required. In addition, small capital, which is not too difficult for the owner to raise, is required for its establishment.
Simple to manage
A sole trader is a small business; therefore, managing it is not complicated. There are not too many divisions to be coordinated and operated. There is also no rigid management, as it can be quickly adapted to suit the prevailing situation; this contributes to its faster response time to the dynamic business environment compared to its larger competitors or companies
The owner takes all the profits
The owner has the sole claim to any profit made. He is the sole provider of capital and must be compensated for risking his finances, which may be all his life savings.
Privacy in handling accounts
The financial records of the sole trader are not required to be published or submitted to any government agency. The public and competitors are not informed about the business’s affairs. Important information is kept confidential and out of public reach.
Quick response to changes
As a small organisation, the owner is closely involved with the customers and employees. He is aware of market changes in a timely manner and can respond quickly. This is why many of them survive while the bigger businesses suffer from diseconomies of scale.
The owner is independent
The owner is not controlled by any party. He makes all decisions without needing endless consultations or approval. As a result, the decision-making process is fast. He controls his time and activities.
Disadvantages of a sole trader
Unlimited liability
The owner will be held liable if the business is unable to settle its debt obligations. He risks losing his personal assets if things go wrong with the business. If the business has no capacity to pay its creditors, the owner’s assets have to be disposed of to settle the financial obligations of the business.
Limited capital for expansion
The amount of finance that can be raised from the owner’s savings is limited. Raising additional capital is challenging because it lacks a proven track record to attract loans from banks. If considered for credit, the interest is usually very high due to the risk it poses to the bank. Investors are also hesitant to provide financing for expansion as they do not want to lose their investment.
The inability to source capital easily limits its expansion drive. The owner may have to turn to venture capitalists in a bid not to miss opportunities. Venture capitalists are prepared to accept the associated high risk, but the owner may have to lose control or sole ownership.
Limited capacity to compete
The business depends solely on the ability of one person, the owner. It even struggles to attract talented workers due to its limited financial resources and inadequate opportunities for staff development. This may stunt its growth or lead to its collapse.
Existential threat
It is improbable that a sole trader will continue operations after the demise or incapacitation of the owner. The business usually ceases operations when the owner is no longer available to run it.
The owner is always overworked
The owner makes a huge sacrifice for the business to succeed. He usually has no holiday or closing time. This puts him under serious pressure and may affect his health, productivity and business continuity.
All the losses are his
Losses are not abnormal, especially for a new business. Since the owner takes all the profits, there will be nobody available to share losses if they occur. It becomes very difficult to find people to help sustain the business if there are recurring losses. A loss-making business is unattractive to stakeholders, including creditors, employees and customers.
No opportunity for managerial specialisation
Due to its small size, the owner is usually actively involved in the management of the business. Managerial duties cannot be shared with other people because one person owns it. If many people owned it, individuals could specialise in whatever managerial tasks they are good at.
The owner and the business are not different legal entities
A sole trader is an unincorporated entity. This means that the business is not seen as a distinct entity from the owner. The decisions of the business are binding on the owner, and it is the owner who is liable to be sued in court when the business is sued.