A sole proprietorship is undoubtedly the most straightforward business structures available to aspiring entrepreneurs. The law allows an individual to form and operate a business under this simplified structure. Opting for this type of business comes with sole proprietorship advantages and disadvantages, which require careful consideration. Many people form a proprietorship to leverage the fewer barriers to starting operations.
A sole proprietor handles the day-to-day operations and reaps the profits of the venture. To achieve success, the sole owner needs to formulate effective operational strategies, launch marketing campaigns, and manage the finances. If you want to learn more to determine if operating as a sole proprietor is a good fit for you, read on to learn the advantages and disadvantages sole proprietorships offer.Table of Contents:
- What is a Sole Proprietorship?
- How a Sole Proprietorship Differs From Other Business Structures
- Examples of Sole Proprietors
- Advantages of a Sole Proprietorship
- Disadvantages of a Sole Proprietorship
Sole proprietorships are the most simple form of business. If you begin to do business activities without any formal registration and you are the sole owner, you are a sole proprietor by default. As an informal business structure, sole proprietorships have no legal distinction between themselves and the company. Thus, the owner files a personal income tax return to account for revenue generated by the business. The law does not recognize this form of business as a separate legal entity. Hence, the owner assumes legal liability and tax responsibilities.
A sole proprietorship can operate using their name or a name that includes their name. If a sole proprietor wants to operate under a different or more brandable business name that doesn’t include their name they can do so by filing for a DBA name. In some states this filing can go by a different name such as an assumed name, fictitious name or trade name.
Sole proprietors are an informal business structure that have a single owner. Partnerships are also an informal business structure that can be used when their are 2 or more owners. Businesses that operate under an informal business structure are not recognized as separate from their owners. As a result they lack limited liability protection.
Formal business structures like LLCs and Corporations are different from sole proprietorships, as they require a formal legal process to be formed. Because of this formal registration, LLCs and Corporations have a distinct advantages in comparison to a sole proprietorship, as they are viewed as legally separate entities from the people who home them. For a more in-depth breakdown of the differences between the various entities types in comparison to a sole proprietorship check out our guide on business types and structures.
A sole proprietor can operate a venture as a small business or an independent contractor. Many home-based commercial ventures are run by sole proprietors. They engage in a wide selection of commercial activities, depending on the owner’s skills and interests. Independent contractors and small businesses offer services and products to consumers and companies.
Some common examples of sole proprietors include:
- Home healthcare service providers
- Financial planners
- Life coaches
- Housekeeping services
- Computer repair services
An Overview of the Pros and Cons of Sole Proprietorships:
|Pros of a Sole Proprietorship||Cons of a Sole Proprietorship|
|Limited Paperwork||Unlimited Liability Risk|
|Cheap to Start||Harder to Secure Business Financing|
|Exclusive Decision-Making Power||Hard to Establish Business Credit|
|Easy Tax Filing||Difficult to Sell Your Business|
You can make an informed decision about the ideal business structure by examining the advantages of sole proprietorship and the downsides. Here are the pros of forming a business as a sole owner.4 Main Advantages of Sole Proprietorships:
One of the best reasons for forming a sole proprietorship is the limited paperwork. It eliminates the need to file an extensive list of documents as part of the registration process. The formation process process of Corporation and LLCs have more requirements such as the filing of legal formation paperwork with the secretary of state. This is one of the biggest advantages when comparing an LLC vs a sole proprietorship.
- Not required to file registration paperwork with the state
- You start operating immediately without informing the authorities.
- You may need business permits or licenses
- Grow business without the burden of government paperwork
- Limited paperwork when registering trade name in the form of a DBA (“doing business as”) and opening a bank account
The ability to save on business registration fees is one of the key advantages of sole proprietorship. This benefit enables you to focus on kickstarting operations. Limited liability companies involve setting aside a significant amount of money for registering the business. Additionally, LLCs pay an annual fee to the state, making the entity’s formation and operation more expensive than a sole proprietorship.
- No business registration fees
- No annual fees paid to the state
- Owners can divert the savings towards starting operations
- Ability to start operations with zero or few employees
As a sole proprietor, you make strategic operational decisions without consulting anyone since the final call rests with you. This capability means you do not deal with pesky partners or investors. As a result, you reach final decisions faster, allowing you to implement changes and boost productivity more efficiently. Complete control makes it easier to steer the venture in the desired direction without anyone opposing the moves.
- Freedom to implement changes
- No need to call partner meetings before reaching a final decision
- Enhance operational efficiency by eliminating consultations
A sole proprietor does not file tax returns under the business name but through a personal tax return. The Internal Revenue Service (IRS) levies taxes based on the profits or losses reflected in the owner’s bank account. Additionally, the IRS applies individual income tax rates instead of rates applicable to companies. These factors simplify and reduce the costs of complying with tax obligations.
- Taxes levied personal returns and not the business
- Personal income tax rates applied by the IRS help reduce the tax burden
- No need to file for an employer identification number (EIN)
Despite the considerable benefits of this business structure, you should not ignore the disadvantages of sole proprietorship.4 Main Disadvantages of Sole Proprietorships:
- Unlimited Liability Risk
- Harder to Secure Business Financing
- Hard to Establish Business Credit
- Difficult to Sell Your Business
Unlimited liability risk is the most significant downside of forming a sole proprietorship. As an owner, you face the risk of lawsuits if the business defaults on debts or undermines third parties’ rights.
- Lacks legal protection provided to the owners of LLCs and other business structures
- Proprietors categorized under self-employed individuals
- Owner liable for tax, legal, and financial shortcomings
- The law allows the seizure of personal assets to recover debts incurred by the business
By forming a business as a proprietor, you may struggle to raise adequate capital. Owners of LLCs and partnerships can secure additional funds easier through co-owners and other sources. Banks and other financial institutions are usually reluctant to fund sole proprietorships.
- Owners are more likely to struggle to raise capital, even if the venture is viable
- Most financial institutions approve loans for established firms
- Lacks the support of shareholders and investors
- Owners may have to take out personal loans to fund the venture with no liability protection
Establishing a solid business credit is one of the disadvantages of sole proprietorship. Unlike other business structures, a sole proprietorship is not a legal entity and does not gain access to loans. Hence, it becomes impossible to build a credit history.
- Owners cannot apply for credit using the business name, compromising the ability to establish a business credit record
- Backing and liability linked to one person
- The business relies on the owner’s credit history
A sole proprietorship’s strong links to the owner undermines its attractiveness to potential buyers. Hence, most businesses of this nature cease existing when the owner retires or passes away. One viable way to recoup some funds when struggling to find buyers is to sell assets instead of the business.
- A strong attachment to the sole proprietor makes it hard to sell the venture
- If a buyer agrees to acquire the company, they cannot use the business name unless the owner registered a DBA (“doing business as”)