It can be difficult to escape sole trader debt, as you’re personally liable for the debts of your business and don’t enjoy the limited liability that’s available to company directors. This means your assets, including your home, are at risk if you’re unable to pay suppliers, tax liabilities, or staff.

Your personal credit rating is also affected when you get into business debt. This can severely limit future borrowing as any defaults or formal debt procedures that you enter remain on your credit file for six years.

Escaping sole trader debt

You can escape serious debt in various ways as a sole trader. Potential options include alternative finance and negotiating more time to pay your tax bill. It’s advisable to seek expert help in this situation, however, as professional input can be a positive influence, both on yourself and your creditors.

So let’s look at some of the processes that may be available, their advantages and disadvantages, beginning with a commonly used debt procedure called an Individual Voluntary Arrangement.

Individual Voluntary Arrangement (IVA)

An Individual Voluntary Arrangement is a formal debt remedy designed to help individuals repay unmanageable debt. It’s available in England, Wales, and Northern Ireland – if you live in Scotland there’s a version of this available, which works in a similar way.

As you’re personally liable for all the money you owe to creditors, you can use the process to repay a proportion of your unsecured business and personal debts. Here are some of the advantages and disadvantages of IVAs:

Advantages

• Your creditors can no longer add interest or charges to any outstanding amounts
• They’re also prevented from forcing you into bankruptcy
• You can continue trading whilst you pay the IVA
• Repayments are calculated with affordability in mind, and by a professional, which maximises your chances of completing the IVA without default
• An IVA is designed to repay as much as possible of your outstanding debt, but if there’s money still owing when the agreement finishes it may be written off

Disadvantages

• At least 75 percent of your creditors, based on how much you owe, must vote in favour of the IVA
• Paying off an IVA can be a lengthy process – it usually lasts five years
• You can’t include secured debt, such as a mortgage, in the agreement
• The IVA can be seen on your credit file for six years and may prevent you from obtaining loans and credit

Bankruptcy to escape sole trader debt

Whilst not an ideal solution, bankruptcy does offer a fresh start if you’re facing relentless pressure from creditors. You’ll lose your assets, potentially including your home, which are sold to repay the debt. A bankruptcy term typically lasts for 12 months.

If your Trustee in bankruptcy decides you’re financially able to repay some of your debts on a monthly basis in addition to using the money generated from your assets, you’ll also have to sign an Income Payments Agreement (IPA) that could continue for several years after you’ve been discharged.

Advantages

• You’re allowed to carry on in business as a sole trader whilst bankrupt
• You’ll be free of debt when the procedure ends
• There’s a fast online application process
• Declaring bankruptcy can relieve the pressure if you’ve been under severe financial strain

Disadvantages

• You could lose your home and other assets of value
• You won’t be able to borrow money or obtain credit for some time
• The bankruptcy order will be seen on your credit file for six years

HMRC Time to Pay arrangement (TTP)

One of the more worrying types of sole trader debt is owing money to HM Revenue and Customs (HMRC). Getting into arrears with tax and National Insurance is a serious matter, but you may be able to secure more time to pay.

The most important step, initially, is to let HMRC know that you can’t pay – this demonstrates that you’re not deliberately avoiding payment. Obtaining professional help to negotiate is a good idea, as there’s a threat of bankruptcy if the agreement fails at any point.

Time to Pay arrangements generally last for six months to 12 months, which may be all the time your business needs to recover financial stability.

Advantages

• You may be able to prevent full insolvency by agreeing a Time to Pay arrangement
• Repayments are made at a fixed rate over a defined period of time
• The agreement gives you time to secure additional finance if necessary

Disadvantages

• You must complete the arrangement without default, otherwise you could face bankruptcy
• HMRC could still apply interest to the debt, plus penalties for late payment
• You can only include your tax and NI arrears in the arrangement, not your current HMRC liability

Debt Management Plan (DMP)

A debt management plan is an informal arrangement with your creditors that helps you repay the money you owe at an affordable rate for your business. As a sole trader you can include both business and personal debts in the plan, but not secured debts.

A licensed debt management firm arranges the DMP, receives your monthly payments, and then distributes the money to creditors according to the agreement.

If you can stick to the debt management plan and keep up repayments, your creditors may not take any further action. Missing a payment, however, increases the likelihood that one or more creditors will take legal action to recover their money.

Advantages

• It’s not legally binding so if your financial situation improves you can cancel the arrangement
• Your debt management company should deal with your creditors on your behalf
• It can be a cheaper option than some formal debt solutions, such as an IVA or bankruptcy

Disadvantages

• Your creditors can still take legal action against you if they wish, as the agreement isn’t official
• Creditors are under no obligation to freeze additional interest on your debts
• The solution is generally for businesses with short-term cash flow problems

Alternative finance for sole traders in debt

Alternative finance could be a good option if your money problems aren’t long-term. Depending on the type of funding, you’d receive a lump sum of cash that could be used to repay your debts, or regular cash sums each month.

If you own any assets of value you could use them to raise cash, for example, or you may be eligible to use the value of your sales ledger to obtain finance if you offer credit to your customers.

Advantages

• You can obtain a cash lump sum if you refinance one of your assets, repay your debts at a more affordable rate, and still use the asset in your business
• Alternative finance options typically offer greater flexibility than ‘standard’ bank loans
• You can tailor the type of finance to your business

Disadvantages

• Your asset may be repossessed if you don’t keep up with repayments
• You need to address the cause of your business’ financial difficulties to avoid serious debt in the future

Although it can seem impossible to escape sole trader debt, tried-and-trusted solutions are available. It’s a good idea to be proactive and approach your creditors early on, however, as you might be able to avoid the extra interest and charges that push you further into debt.