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Being a sole trader: the advantages and disadvantages

A sole trader plasterer

If you’re thinking about starting a business in New Zealand, one of the first few things you need to consider is business structure. Before you decide which business structure to choose, you should have a full understanding of the benefits and drawbacks of each.

In this blog, we’ll explain what a sole trader is and the pros and cons.

What’s a sole trader?

A sole trader is one of the common business structures for small businesses in New Zealand. The other common business structures are partnership, company, and trust. Being a sole trader means you’re the only owner of your business. 

As a sole trader, you’re responsible for paying your income tax and GST (if you’re GST registered). Many small business owners choose to change their business structures to companies or partnerships as their businesses evolve. This may have implications on how you run your business, your responsibilities, tax obligations and more. 

The advantages of being a sole trader

You’re your own boss

One of the key benefits of being a sole trader is that you can be your own boss. This means you dictate the direction of your business and are accountable to yourself. This might be the biggest reason why people ditch their 9-5 job. 

A sole trader has more freedom with decision-making compared to other business structures. For example, if you operate your business as a partnership, your partner will likely be involved in making business decisions and the direction of the business.

Low cost and ease of set up

Being a sole trader is relatively easy as you don’t have to register with any government agencies. You can get started straight away, providing you have an IRD number (for paying income tax and GST if you are registered), professional licenses, business permits (if needed), and qualifications or registrations for your trade or profession (if needed). You can start your business anytime you want. 

Depending on your industry, the only fee you may need to pay is to open a separate bank account for your business. You might also want to pay for a cloud-based accounting software such as Xero, its cost is very minimal. Therefore, for sole traders just starting out, low costs and ease of setup are appealing. You can switch to other business structures as you grow your business  (we’ll cover this later). 

Keep all the profits

Another advantage of being a sole trader is that you can keep all the profits. However, if you are running a business through a partnership or a company, you may need to share the profits with your partner or shareholders. 

Easy to change your business structure later

If you want to start small and expand your business later on, being a sole trader makes this easier for you. Changing to other business structures (e.g., partnership, company, trust) is fairly easy because you don’t have to go through the process of dissolving and stepping down from your business. If your business income starts to increase, you could potentially change to a limited company to be more tax efficient. 

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The disadvantages of being a sole trader

Unlimited liability 

One of the biggest disadvantages of being a sole trader is you will have unlimited liability. When you’re operating as a sole trader, you and your business will often be seen as one entity. This means there’s no protection for your personal assets. You’ll also be responsible for any debt your business incurred - the worst-case scenario is that you could lose your house to pay off your business’s debt! As a result, being a sole trader may come with its own set of risks.

Difficult to grow

Another disadvantage is the difficulty of growing your business. When your business starts to expand, it’s harder to secure funding to support your business’s growth. Unlike a partnership or company, sole traders don’t get the extra funding from other partners or shareholders. For example, in a company structure with few shareholders, you can easily raise funds from each shareholder; compared with a sole trader, which depends on you solely to provide all the funds. This adds more pressure on the sole trader financially. Therefore, you may consider changing your business structure when you need fundings to grow your business. 

Be the decision maker in everything

Full control over your business can be an advantage, but also a disadvantage sometimes. You have to make all business decisions and are solely responsible for the decisions you made. It can be stressful sometimes because the business is reliant on you. If the business fails, you’ll be taking full responsibility. 

Tax may not be efficient 

Sole traders are taxed as individuals, it can be as high as 39%. You can find the tax rate here. However, companies are taxed at a flat rate of 28% in New Zealand, and trusts are taxed at 33%. You can find more details on IRD’s website. In this case, both of those structures are taxed at a lower rate compared with sole traders. As a result, sole traders are less efficient when it comes to working around the tax system.

 When the business starts, you normally have more expenses due to business setup, compared with income you earned. During that time, sole traders may be more tax efficient. As you could offset your business losses with your other income, which may give you a tax refund position at the year end.

 However, we all expect our business to grow in a positive and sustainable way. When the business grows, all the profit made in a sole trader structure will need to be returned in your personal tax return. If your total income from all sources, including your sole trader business income, exceeds $180,000, then you’re expected to pay up to 39% of the tax. However, if you operate in a company structure, the flat tax rate is only 28%. Be aware that there are specific rules for people who provide personal services. The tax rule is slightly different. 

Harder to sell

Being a sole trader could make it harder to sell when you want to sell and exit your business. This is because your business and yourself are seen as one entity. In other words, your business is often linked with your personal assets. As a sole trader, your business is built on your personal reputation, goodwill, skills or performance. This becomes an issue when you try to sell your business and exist, as it is hard to separate those intangible assets from you. Therefore, if you wish to sell your business, you may want to consider starting with a company and building all those intangible assets in the company, which later you could sell it. 

Key takeaways

Choosing a business structure that suits your business and personal circumstances is crucial in the startup phase. Many small businesses choose to operate under the sole trader structure in the beginning because it’s easy to set up and minimal paperwork is required. However, sole traders are not the best business if you wish to grow your business. You will have unlimited liability, which means you’ll be personally liable for all business debts. And as a sole trader, it limits your growth with limited funding, knowledge and time. Sole traders can be tax efficient to start with, but as you grow, you may lose the tax benefits. And that is when you may want to consider changing to a different structure.

Who are Beany?

We’re an online accounting firm that is always right here for you, your accounting pain relief. The most advanced technology lets us work way more closely with you than a normal accountant world. ​

We have a dedicated team of certified accountants and a support team to take care of your business no matter where you are, so you can focus on growing your business. We take out the ‘fluff’, break down the barriers and get things done. Looking out for you is what we are all about. Get started for free today.

Tori as a dog

Tori Ma

Performance marketer

Performance marketer at Beany, and into true crime documentaries.

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