Increased regulation is deterring small businesses from recruiting staff and entrepreneurs are instead choosing to work on their own.
That is the conclusion of a report commissioned by the Federation of Small Businesses (FSB), which has revealed sole traders are on the increase while companies with less than nine employees are falling.
According to the FSB, this is an issue because "the smallest businesses are the best employers".
Commenting on the results of the report, John Walker, national policy chairman of the FSB, said: "Small businesses are clearly good employers who look out for their employees, offer them flexible working and are more likely to employ those who were previously unemployed.
"However, the figures also show that regulation is a real burden for employers who cannot keep up with more and more complex law and red tape."
The report revealed that only one if five employers were happy with employment law.
Mr Walker went as far as to say that the reduction in the number of small businesses was "a real loss to the economy".
The FSB has recently called on the government to delay new laws, which it claims could cost small businesses £800 million.