Sole Traders and Partnerships

There are many ways in which businesses can be classified and categorised. From the perspective of their legal identity, we will divide businesses by considering those that have limited liability and unlimited liability.

Liability

Liability in this context, refers to whether the owners of a business can be legally forced into selling their personal items of value (assets) to pay off outstanding debts of the business. Owners of businesses with unlimited liability can be forced to sell their personal assets whilst owners of businesses with limited liability can only have the assets registered to the business seized by those the business owes money.

Unlimited Liability Businesses

Let us look at unlimited liability businesses first. Broadly speaking, there are two types of business with this level of liability. They are sole traders and partnerships. A sole trader is a business with one owner and is the most common form of legal structure.

Sole Trader

The business has unlimited liability because the owner and the company are viewed as the same entity in the eyes of the law. In other words, the sole trader business cannot continue if the owner dies and the owner has to pay income tax on any profits the business makes. This also means that the business owners are allowed to access the funds of a business for their own personal use at any time.

Sole traders tend to be small businesses and are very easy to set-up because there are no administration costs or registration processes involved in getting started. A person could quite easily set up a sole trader business today by purchasing some stock and selling it online. Because they are relatively small businesses, there are often no additional employees within a sole trader business.

Many business owners that adopt this model, may themselves only run the basis as a part-time or hobby business. Take for example a taxi driver, a market stall trader selling fruit and vegetables or the owner of an ice cream van. These business owners can decide on their own working times and can work whenever they want. There are very few obligations for them to operate everyday, although they do tend to work longer hours in order to earn more money.

The owners of a full-time sole trading business may actually find that they take little time off because the business earnings are linked to them being present to run the business. As a result, they have a lot of engagement with customers and can respond to changes in the market quickly.

Expansion is normally quite challenging because there is a heavy reliance on the wealth of the individual owner. Decision making, time management, operational planning and any basic aspect of running the business will be the responsibility of the individual owner.

Partnerships

Partnerships are the other type of business with unlimited liability. As with sole traders, they are relatively simple to set-up but there are at least 2 owners of this type of business. The owners will generally know one another quite well and will share the risk and rewards of the business.

There is no upper limit to the number of people that can be involved in a partnership, but it is rare to see more than 20 partners and the partnership size is normally between 2 and 20 people. Normally, if the partnership starts to involve too many people, the legal structure of the business is altered by those owners to safeguard everyone’s wealth.

Being involved in a partnership offers access to additional resources but also involves the sharing of resources. However, partnerships allow the business owners to have more flexibility in their time off and can facilitate expansion opportunities with the wealth that partners can generate.

In deciding on whether to choose an unlimited liability structure, the business owner of a partnership or sole trader needs to assess the risks of losing personal assets against the flexibility the business structure provides.