What happens to sole traders when their business becomes insolvent?

As a sole trader, there is no legal separation between you as an individual and your business. If your business faces financial issues or becomes insolvent, you, as the owner, are required to cover any financial gaps and repay outstanding borrowing using your personal funds. In severe cases, a sole trader might need to explore personal insolvency options, like an IVA or bankruptcy, if business debts cannot be settled.


Sole Trader Insolvency: Unfolding the Fate of Myself and My Business

When a limited company becomes insolvent, directors are shielded from personal liability by the ‘veil of incorporation.’ In contrast, sole trader businesses are not considered separate legal entities.

As a sole trader, it becomes a personal insolvency matter, and you are entirely responsible for your business debts. This puts you at risk of personal bankruptcy if you cannot repay creditors.


Exploring the Insolvency of a Sole Trader Business

A gradual and sometimes inconspicuous decline in business can result from various factors, such as delayed invoicing, sluggish debt collection, and holding excessive stock. Even if your business is profitable, the lack of sufficient cash to support daily operations is a common reason for business failures.

It is crucial to seek professional insolvency assistance as soon as you detect a problem. If the business becomes insolvent, your business and personal debts may be merged, potentially leading to the need to declare bankruptcy.

Sole traders have two formal routes when they become insolvent:


Individual Voluntary Arrangement (IVA)

An Individual Voluntary Arrangement (IVA) is a formal and legally binding insolvency process that typically spans about five years. If an insolvency practitioner deems the business viable, they may propose an IVA and initiate formal negotiations with your creditors.

After reaching an agreement, creditors cannot pursue legal action to recover the debts covered by the arrangement. However, you must consistently repay the agreed amounts throughout the IVA term. Failing to do so may prompt a creditor or the IVA supervisor to petition for your bankruptcy.

Advantages of an IVA:

  • Repayment funds for an IVA can be sourced from future business profits or through the sale of an asset/refinancing.
  • Enhanced cash flow, with the option to include personal debts in the arrangement, excluding the mortgage.



Implemented bankruptcy: If a creditor is owed £750 or more and has unsuccessfully attempted to recover the debt through a County Court Judgment and Statutory Demand, they can seek your bankruptcy through the courts. This threshold has temporarily increased to £10,000 under the Government’s measures from October 1, 2021, to March 31, 2022.

HMRC often employs this method to reclaim tax and National Insurance arrears from businesses deemed insolvent. However, if the business remains viable, there might be ways to enhance the financial situation, such as refinancing or negotiating an IVA.


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The Process of Declaring Bankruptcy

Declaring bankruptcy is typically a last-resort measure, but in certain cases, it can alleviate a period of extreme stress and pressure for sole traders, even though personal and business assets are forfeited.

  • The assets are then assessed and may be sold to repay creditors.
  • You initiate your own bankruptcy through the courts and relinquish control of your assets to an appointed supervisor
  • You don’t automatically lose your home; it depends on the available equity and whether it is worthwhile for the supervisor to sell it.
  • The bankruptcy period usually lasts for 12 months, after which you are released from its constraints and can begin rebuilding your credit rating.


The bankruptcy petition form can be intricate and complex, so you might consider seeking professional assistance. If you think your sole trader business is insolvent, Vanguard Insolvency can assess your financial situation and provide tailored recommendations.

As insolvency specialists with a network of 100 UK offices, we can schedule a free, confidential same-day meeting to discuss your situation. 

David Jackson MD
Senior Partner at Vanguard Insolvency Practitioners | Website

I am an insolvency professional with a distinguished career specialising in commercial insolvency, adeptly navigating Creditors Voluntary Liquidation, Company Voluntary Arrangements, and Company Administrations. With a comprehensive understanding of insolvency laws and an unwavering commitment to ethical practices.