I have been meeting many business owners of late who are trading as a sole trader and it makes me cringe.
My first question is WHO advised you to do this? And most times, the answer is, oh I did it myself it was easy, I just registered an ABN and off I went, or my Accountant said that a sole trader would be best to try out my idea.
Anybody who knows me well, knows I am NOT a poker player – everything on my face tells you what I’m thinking…. And those answers makes me want to cry.
See, I’m a forward thinker. I always want to make my future self proud of me, and I want my clients to have the same future ease. Start with the end in mind as Steven Covey says.
Ok what’s the drama with setting up as a sole trader?
Look, I get it, starting a business as a sole trader can be an attractive option for many entrepreneurs in Australia, especially those who are just starting out. As a sole trader, you have full control over your business and can make decisions without having to consult with others. However, there are also significant risks associated with running a sole trader business, and it is essential to be aware of them before you start.
Personal Liability
The biggest risk of running a sole trader business is personal liability. As a sole trader, you are personally responsible for any debts or legal issues that your business may incur. This means that if your business is sued or goes bankrupt, you could lose your personal assets, such as your home or car, to pay off your debts. This risk is particularly significant if you are providing professional services, as you could be held personally liable for any mistakes or errors that you make.
From a tax perspective, this also means the full profit is recorded as your taxable income, and when you begin to earn above certain thresholds, this means you’re paying more tax than you would if trading as a Company, meaning less money stays in your pocket and more goes to the government in taxes.
Financial Security
Another risk of running a sole trader business is the lack of financial security. Because you are the only person running the business, you are solely responsible for generating income and managing your finances. If your business is not profitable, or if you face unexpected expenses, you may struggle to stay afloat. This can put significant stress on you and your family and could even lead to personal bankruptcy.
Trading ethically as a company may allow the company to be liquidated, and your personal assets to be protected.
Also, if you get injured whilst at work, your income and health costs won’t be covered by employee insurance (i.e. work cover, iCare, workers compensation insurance etc) because this insurance doesn’t cover sole traders or partners in business. Alternatively, if you were trading as a company and were an employee of that company, work cover insurance would protect you.
Lack of support and resources
One other risk of running a sole trader business is the lack of support and resources. As a sole trader, you do not have access to the same resources and support as larger businesses. This means that you may have to do everything yourself, from marketing and sales to bookkeeping and accounting. This can be overwhelming and time-consuming, leaving you with less time to focus on growing your business.
Reduced benefits from not trading as a company
Finally, as a sole trader, you may also miss out on some of the benefits of being part of a larger organisation. For example, you may not have access to group buying discounts or be able to offer your employees the same benefits as larger companies. This can make it harder to attract and retain top talent, and may limit your ability to grow and expand your business.
I’ve also seen plenty of government grants and business negotiations, and even trade insurances fall through the moment they realise the entity is trading as a sole trader, which can significantly limit your revenue potential.
Common myths about running a company
Many people think that a company is significantly more cost to get setup and to operate a company. Back in the 1990’s this was definitely the case, but these days, Companies can be setup with ease and although there are a few extra costs per year (eg work cover for your employment; annual ASIC fee) it’s not more than $1-2k p.a. Everything else is still similar to the sole trader, but you get the added benefits significantly improved options for how much tax is paid and protecting your personal assets from the business activities. That in my mind, is well worth the minimal additional costs.
What if I’m already trading as a Sole Trader and want to switch as a Company?
If you’ve already started trading as a sole trader and are keen to switch to a Company, the biggest hurdle you need to overcome is understanding that the switch involves a brand new legal entity. Which generally means, new bank accounts and new Xero file, and the money in the bank is no longer yours to spend (because it belongs to the Company).
There are a few other things you need to consider before making the rapid switch which I’ve addressed in a previous blog post found here.
Summary
While starting a business as a sole trader can be an attractive option for many entrepreneurs in Australia, it is important to be aware of the significant risks involved. Personal liability, financial insecurity, lack of support and resources, and missing out on the benefits of being part of a larger organisation are all potential risks that you need to consider.
To mitigate these risks, it may be worth considering alternative business structures, such as setting up a company or unit trust. If you want to learn more, book an appointment below with our business coach and Chartered Accountant, Jewlz Ellem