The most basic of all business legal structures is the sole proprietorship. For new start-ups, the choice of becoming a sole proprietorship is the simplest of all business forms but is it the best? Learn the pros and cons of a doing business as a sole proprietorship.
- A sole proprietorship is a business with one owner that isn't a corporation. The business owner typically pays personal taxes on their business income.
- Sole proprietorships are easy to set up and tax filing is simpler than with corporations.
- The biggest drawback of a sole proprietorship is that the business owner is personally liable for the business, meaning their personal assets could be at risk.
What Is a Sole Proprietorship?
A sole proprietor is a business of one without a corporation or limited liability (LLC) status. The individual represents the company legally and fully. Common sole proprietors include freelancers, independent contractors, and consultants. Sole proprietorships provide several advantages as well as disadvantages.
Pros and Cons of a Sole Proprietorship
Quicker tax preparation
Lower start-up costs
Ease of money handling
Lack of financial controls
Lonely at the top
Difficult to raise capital
- Quicker tax preparation: As a sole proprietor, filing your taxes is generally easier than a corporation. Simply file an individual income tax return (IRS Form 1040), including your business profits and losses. Your individual and business income are considered the same, and self-employed tax implications will apply.
- Lower start-up costs: Limited capital is a reality for many startups and small businesses. The costs of setting up and operating a corporation involve higher set-up fees and special forms. It's also not uncommon for a lawyer to be involved in forming a corporation.
- Ease of money handling: Handling money for the business is easier than other legal business structures. No payroll set-up is required to pay yourself. To make it even easier, set up a separate bank account to keep your business funds separate and avoid co-mingling personal and business activities.
- Personally liable: You are personally liable for all debts and actions of your sole proprietorship. Unlike a corporation or LLC, your business doesn't exist as a separate legal entity. All your personal wealth and assets are linked to the business. If you operate in a higher-risk business such as manufacturing or consumables, the cost-to-benefit ratio is favorable toward a corporate structure.
- Lack of financial controls: The looser structure of a proprietorship won't require financial statements and maintaining company minutes as a corporation. The lack of accounting controls can result in the demise of your small business. No matter the legal structure of your business, take the time to set up the proper financial statements for your company.
- Lonely at the top: Being a business of one can be lonely. All the decisions, actions, and results rest on you. Are you able to work alone and be productive? If not, it may make sense to bring in a partner to ensure your small business's survival.
- Difficult to raise capital: Imagine your business in five years. Will it still be a business of one? Growing your small business will require cash to take advantage of new markets and more opportunities. It may be easier to attract investment dollars if you incorporate your company.
Forming a Sole Proprietorship
From the IRS's perspective, your small business is a sole proprietorship unless you have registered it as a corporation or other business structure such as an LLC. Setting up your proprietorship often does not require registration of the business. If you are planning to use another name or business name to operate your company, state laws will require a trade name registration or filing of your company name.
Choosing the best business structure for your business will depend on a host of individual factors including your type of business, tax situation, industry liability, among others. Your choice of business structure will have legal and personal implications. While you don't need to hire someone to start a sole proprietorship for you, you may consider paying a professional to help you assess whether you should form a corporation or LLC.
Frequently Asked Questions (FAQs)
What are three disadvantages of a sole proprietorship?
Some drawbacks to sole proprietorships include the business owner being personally liable for the business, the loneliness of being the only employee, and the difficulty you'll face if you want to raise capital.
What are the advantages of a sole proprietorship over a partnership?
Sole proprietorships are much easier to set up, taxes are simpler, and, as the only employee of a sole proprietorship, you have the power to change and modify the business however you please.