The advantages and disadvantages of being a sole trader vs a partnership

The nature of a sole trader

A “sole trader” is a person who is in business on their own account – essentially self-employed. A sole trader business doesn’t have to have just one employee (the “sole trader” himself) but can have many employees. However, the sole trader is generally the person running the business.

A sole trade earns his income (he can be anything from a hot-dog vendor to a sole practitioner solicitor) from payments from his customers or clients. The sole trader’s profits are taxed as income. He is liable to pay Class 2 National Insurance Contributions whether or not he makes any profit and must pay Class 4 National Insurance Contributions on profits. As with any self-employed person a sole trader is required to register for Self-Assessment on his taxes and complete and return a tax return annually.

Being a sole trader is the simplest way to run a business as there is no requirement to pay registration fees, the sole trader keeps all the profits, and the keeping of accounts is relatively straightforward. Further, the sole trader has the right to make all decisions relating to the business and owns all the assets of the business.  However, a sole trader is personally liable for the debts of the business. This means that if business goes badly then the sole trader can go bankrupt. This is obviously rather serious and requires a balancing in the mind of the sole trader between the risks and rewards of operating as a sole trader.

The nature of a partnership

There are three types of partnership:

  1. Ordinary partnerships
  2. Limited partnerships
  3. Limited liability partnerships

Ordinary partnerships are covered in this post. Limited partnerships and limited liability partnerships will be covered in a future post.

“Ordinary” partnerships are governed under the Partnership Act 1890. A partnership occurs where two or more legal or natural persons carry on business together as equals. An important point to note is that partnerships don’t have to be between two “natural” persons (i.e. humans like you and me) – they can be between “legal” and “natural” persons, such as companies or other partnerships.

The partners in a business divide the profits and the losses of the business between them, unless the partnership agreement specifies otherwise. Each partner is responsible for pay tax on their share of the profits and for making the correct National Insurance Contributions.

The advantages of a partnership are that there are very few formalities in setting it up. This means that there is generally less hassle and expense. Further, a partnership (unlike a private or a public company) has no memorandum or articles, is not required to register, is not required to have its accounts available for public scrutiny, doesn’t require a written agreement (although it’s recommended that such is obtained), and is not subject to the swathe of rules that companies are subject to.

The disadvantages of engaging in a business partnership is that the partners have unlimited liability for the debts of the partnership both jointly and severally. This means that all or any one of them could become liable for the entire debts of the partnership. As with sole traders, those persons engaging in a partnership could potentially be bankrupt by the business (although this problem doesn’t generally apply to limited companies). Further, a partnership may find it more difficult to attract investment than a private or public company – it can’t issue debentures, for example.

Our specialist commercial solicitors’s view on sole trader vs partnership

Which business model you chose to adopt for your business will be wholly dependent on your circumstances and the business that you wish to engage in. The advantages of both models are, generally, their flexibility and lack of administration (as compared to companies, for example). However, there are substantial disadvantages to being a sole trader or a partner and the most substantial is the potentially unlimited liability that you can incur. This can lead to bankruptcy.