Sole Trader Troubles: Why the majority of sole traders don't make it.
Updated: Aug 2, 2019
At a glance
- 20% of sole traders don’t make it past their first year, 60% will fail to make 5 years, rising to 80% by 12 years. (IFS, 2019)
- Between 2011 and 2016, 6 million people were sole traders for at least one year but only 40% (2.4 million) were sole traders in all 5 years. (IFS, 2019)
- Aggregate profit of all sole traders was 2% lower in 2015-16, with 800,000 more sole traders, than in the financial crisis of 2008. (IFS, 2019)
What is a sole trader?
There is some confusion as to whether a sole trader is any different to those classified as self-employed or as sole proprietors. Essentially, there is no difference between these classifications, and you can be considered as more than one at the same time, i.e. a self-employed sole trader. Self-employed simply suggests that you don’t work for an employer, and that you are responsible for the payment of your taxes through self-assessment, rather than PAYE. As you don’t work for an employer, you will also not be entitled to standard employment benefits, such as payment for sick leave or holiday leave allowances. Sole Trader or Sole Proprietor refers to the structure of your business, i.e. you are the sole owner of your business, and you are individually responsible for the success or failure of the business. Sole traders make all the decisions regarding which clients they work for, how many clients they have, what work they do, and how and when they do it. Sole traders are afforded the benefits of keeping all profits made after tax, however, are also personally liable for any losses that the business makes. A sole trader does not have to register with Companies House or have a director, making it a very simple business structure for individuals starting up on their own. VAT still applies to sole traders, if their business turnover is more than £85,000 in a calendar year. More information on the VAT system, Making Tax Digital and registering, can found in our previous blog post.
Majority of UK businesses are sole traders
The sole trader business structure is the most popular form of business classification in the UK, accounting for 55% of all businesses. This makes sense, given the ease at which a sole trader entity can be formed and managed by individuals. As seen in Figure 1, the data released by the Department for Business, Energy & Industrial Strategy in October of 2018 shows the number of sole traders operating in the UK has grown from 2.4 million in 2010 to 3.1 million in 2018. However, it also highlights a slowing of this growth since 2014; something not experienced by the remainder of UK businesses.
Figure 2, also based on the Department for Business, Energy & Industrial Strategy dataset, compares the volume of UK businesses against their turnover. It illustrates that although sole traders comprise 55% of all businesses in the UK, their contribution to turnover only equates to 2.9% (£113.8 billion). The remaining 45% of UK businesses generate the bulk of the turnover, 97.1% (£3.7 trillion).
Low income and low profits for sole traders
The Institute for Fiscal Studies (IFS) found in their 2019 study of sole traders that for 2015-2016 period, the average taxable income of sole traders was £21,000 per year (as compared to the average UK income of £29,850). It was 14.3% higher for the 52% of UK sole traders that had remained in business for 4 years, at £24,000 per year. The costs associated with doing business as a sole trader varied; 23% had costs of less than £1,000, 70% had costs of less than £10,000, and 7% reported making a loss (costs exceeded sales). Although positive, with only 7% of sole traders making a financial loss, 70% experienced costs up to nearly half of their revenues, leaving little remaining for profits after tax.
In 2015-2016, the aggregate profit of UK sole traders was 2% lower than the aggregate profit in 2008. This 2% fall in aggregate profits occurred despite 800,000 more sole traders operating in 2015-16 than in 2008. This is interesting and would indicate that whilst there are more sole traders operating, they are generally less profitable. In fact, since 2008, the average annual sole trader profit has declined from around £15,500 to around £12,000. This is reflected in the drop in sole traders earning annual profits of over £40,000 from 7% in 2007/2008 to 3.9% in 2015/2016. During the same period, there was an increase in sole traders earning annual profits up to £2000, from 12.1% to 14%.
High start-up and attrition rates of sole traders
According to the IFS, 20% of sole traders don’t make it past their first year, 60% will fail to make 5 years, rising to 80% by 12 years. The IFS also reported that between 2011 and 2016, 6 million people were sole traders for at least one year, but only 2.4 million were sole traders in all 5 years. Between 2014-2015 and 2015-2016 the sole trader population grew by 70,000, however, this was the result of 650,000 sole traders starting up and 580,000 ceasing operations. The reasons for these sole traders closing their doors is varied, however IFS identified specific factors that trended more commonly across business closure than others, namely; the age of the owner, years in business, profits and turnover.
IFS went further to analyse the impacts of these characteristics on the likelihood of closure for sole trader businesses. The two most impactful characteristics on the longevity of sole trader businesses were turnover and years in business; the former being 3 times more impactful than profit, and the latter 2 times more impactful than the age of the owner.
Figure 3 highlights this trend for the relationship between age of business and failure rates and turnover and failure rates. When compared to sole traders in their first year of operation, sole traders in their 2nd, 5th and 10th years of operation were 2.6, 5.1, and 7.7 percentage points less likely to close in any given year. Sole traders with a turnover in the 2nd, 3rd, 4th, and 5th highest quintiles (i.e. higher revenues) were 8.1,12.1, 13.7, and 12.2 percentage points less likely to close than those in the lowest turnover quintile.
Improving your chances of success as a sole trader
Sounds obvious, but with increased numbers of sole traders in operation, your share of the market is likely to diminish. How can you grow your revenues in an increasingly crowded market?
Sole traders, like other businesses, need to look for market opportunities where others aren’t to expand their market share. Offering the same products or services to under-serviced, niche or unexplored market segments will help to grow revenues. This could include exploring new sales and marketing channels to expand your brand awareness and visibility
Depending on the products or services offered, diversification can also serve to create increased revenues, and competitive advantages, when your current market segment is over-subscribed. (Note: in the pursuit of diversification, cost-benefit analysis should be performed to ensure the extra costs incurred don’t outweigh the benefits)
Increase Business Longevity
The longer that a sole trader is able to stay in business, the less likely they are to cease operations. How do you improve your business longevity?
Understand your competition. In an increasingly crowded market, knowing what your competition is offering, their strengths and their weaknesses, will enable you to adjust your business model to optimise your product or service delivery, creating competitive advantage
Set business goals & develop a strategy. If you don’t plan your business beyond the first 6-12 months of operation, its probably not going to last much longer than that. If you want your business to grow and be sustainable, a set of defined short, medium and long-term business goals should be developed to inform decision making and form the basis of any strategy development.
Logically, increased turnover should mean increased profitability – but this isn’t always the case. Rather, increasing profitability is a balancing act that is equal parts increasing or maintaining turnover, whilst maintaining or reducing costs.
If cashflows permit, an investment in revenue growth can be very beneficial to business growth strategy. Adoption of new technology, product or service delivery, or business efficiency can support your longer-term business goals.
Equally, if cash is tight, a cost reduction, efficiency programme or tax optimisation strategy may also deliver the increased profitability your business needs.
If you’re a sole trader, or thinking of becoming one, contact us and we can help you to plan your business strategy, improve your financial position, and help your business become more sustainable.
Strathearn Strategic Consulting
+44 (0) 7913 413 699