Small business owner on a laptop

What exactly is a small business?

September 3, 2021

If you have launched your own startup or are currently operating as a sole trader or contractor, it's likely that at some point or another you've been referred to as a small business.

It's certainly a phrase we hear a lot. If you listen to the news or pick up a paper, there are numerous segments, features and articles on small business births and deaths, economic performance, tax and government support and investment.

However, you might be wondering what exactly a small business is. For some people, it's a self-employed small business owner running their own company part-time; for others, it's a small, local firm that operates full-time and employs fewer employees than comparatively larger companies.

In this article, we'll cover what a small business is, what the small business size standards are and why knowing the size of your business can benefit you.

What is a small business?

The dictionary definition of a small business is an independently owned and operated business that does not employ many people and has a low sales volume. Even though this gives you a picture in your mind, it's still not especially clear what you would classify as a small business. How many employees is considered too many? What is regarded as a low volume of sales?

Depending on who you ask, you may get a variety of answers. That's because the classification of a small business can change depending on the organisation or country defining how the size of a company is measured. There are different rules for what is and isn't considered a small business, even within the UK government.

For instance, to claim Research and Development tax credits, HMRC uses different figures from the rest of the government departments. Likewise, Ofgem, the Office of Gas and Electricity Markets, would prefer to base their definition on the amount of energy that a business uses rather than the number of employees or annual turnover.

If all of this seems confusing, there is no reason to panic. For accounting purposes, Companies House uses a standard definition to define what a small business is – one of three categories that fall under the parent category of an SME.

What is an SME?

Many small businesses are lumped under the title of small to medium enterprises (SMEs), which is not surprising given that SMEs make up over 99% of the private sector businesses in the UK. Parliamentary research shows that in 2020, there were just under six million businesses classed as SMEs. To highlight how large a figure this is, only 8,000 private sector businesses were not classed as SMEs.

Three categories make up the umbrella term of SME. Your business will be one of the below if it satisfies any two of the three criteria:

Micro-business

  • Annual turnover: £632,000 or less
  • The total amount on the balance sheet: £316,000 or less
  • Number of employees: 10 or fewer

Small business

  • Annual turnover: £10.2 million or less
  • The total amount on the balance sheet: £5.1 million or less
  • Number of employees: 50 or fewer

Medium business

  • Annual turnover: £36 million or less
  • The total amount on the balance sheet: £18 million or less
  • Number of employees: 250 or fewer

Traditionally, most businesses that only employ a few staff members have been referred to as small businesses, but the term micro business will often be more appropriate.

Of the six million private-sector SMEs operating in 2020, 1.4 million had employees, and 4.6 million had no employees. If we think about the number of sole traders, contractors, freelancers and limited companies, this makes perfect sense. The structure of these small enterprises – including a diverse range of professions such as plumbers, IT consultants, hairdressers and developers – typically only have one member of staff in the company: the owner. Of the nearly six million private sector businesses in the UK, 5.73 million are micro-businesses and have fewer than 10 employees.

Does it matter how my business is classified?

You may not think that your business's size is essential, but there are many benefits to being considered a micro-business or small business.

Grants and funding

It can be hard work starting a business. Trying to find your niche in what is often a crowded industry can take time. Unfortunately, time isn't always something you have an abundance of, especially if you are struggling to generate enough income or having problems with cash flow.

It's not just startups who can find it difficult. Many successful business owners struggle to expand and grow their companies without an injection of cash.

If you don't have your own means of funding your startup or expansion plans, how can you put money into the business without the help of an angel investor?

This is where funding can help. From government Research and Development schemes to local authority grants, there are all manner of small business grants available to SMEs, depending on the size of your business.

As we discussed earlier, not all organisations use the same parameters to define the size of a business, but all of them will work on the same metrics: the number of people you employ, your annual turnover and the amount of money on your balance sheet.

This is where knowing these figures can really help you, especially if you plan to deal with multiple funding bodies.

Accounting requirements

All businesses have an obligation to complete an annual tax return to HMRC, but if you are a limited company, there are additional obligations you have to meet. Limited companies must send an annual account to HMRC as part of the Company Tax Return and Companies House.

The rules, however, are slightly different if you run a micro-business or small business.

If your company is a micro-business, you can:

  • file simpler accounts
  • send only your balance sheet to Companies House
  • take advantage of the audit exemption

If your company is a small business, you can:

  • send abridged accounts to Companies House (if all company members agree to it).
  • take advantage of the audit exemption
  • choose whether to send a profit and loss report to Companies House

IR35

The new IR35 rules have been in place since 6th April 2021. This piece of legislation determines if an employee should be classified as a 'deemed' employee and if so, they pay Income Tax and National Insurance contributions.

If you are a freelancer, contractor or small business owner, you need to be up to date with the latest information as it can affect how you operate. If you aren't familiar with the rules or are unsure if they apply to you, then take a look at our comprehensive guide to IR35 and why an IR35 review is important.

For IR35, the distinction between a small business and a medium-sized business is essential. If you are considered a small business in the private sector (based on the criteria for SME's), then the responsibility for determining IR35 status is on the contractor. For medium-sized private sector businesses, the responsibility for carrying out these checks sits with the company.

Business rates

This isn't based on the same criteria for determining SMEs, but there is a benefit to being classed as a 'small' business when it comes to paying business rates.

HMRC charges businesses a fixed business rate for non-domestic properties that are used for business purposes. As you might expect, this includes premises that are used as:

  • shops
  • pubs
  • offices
  • factories
  • warehouses

The rate is similar to Council Tax on domestic property and is used to fund services in the local authority.

Business rates are calculated based on the 'rateable value' of a property – the open market rental value on 1st April 2015 – based on an estimate by the Valuation Office Agency.

You can estimate your business rates by finding the value of your property and working out which multiplier to use. If your property is worth over £51,000, you should use the standard multiplier of 51.2p, and if it's below £51,000, you should use the small business multiplier of 49.9p.

If your property's rateable value is below £15,000, you can qualify for small business rate relief, and you won't have to pay anything if the value is £12,000 or less.

Why are small businesses important?

As we have demonstrated by the makeup of SMEs, we include any company that employs 50 people or fewer (small and micro-businesses) when we refer to small businesses. These two types of business make up an overwhelming majority of private sector businesses in the UK and provide employment for just under 50% of the employment-population in that sector.

Small businesses are invaluable as they:

  • Create employment for millions of people
  • Provide a platform for startups and entrepreneurs to inspire innovation and be at the forefront of change in their respective industries
  • Develop new products and services
  • Build communities
  • Create opportunities that don't always exist in large companies

Are you thinking of launching your own small business? Check out our guide on how to start a business.

Whether you set yourself up as a contractor, sole trader or a limited company, you'll need to stay on top of your accounts. This is where Ember can help. Our accounting software is designed for business owners, not accountants, meaning it's easy to manage your finances, submit your tax returns, categorise transactions and run your payroll.

Join us in creating the new age of accounting.

Simple language, simple software, so that you can spend less time dealing with admin and more time focusing on what really matters.

Rachel Cameron-Potter

Rachel is a Content Marketer at Ember with a love of writing, editing and all things creative. After graduating from York with a degree in English, Rachel has dabbled extensively in content creation, working as a fundraising lead for a letterpress studio, a digital marketer on a political campaign, a magazine editor, voice over artist and freelance writer.