Sole Proprietorship: Advantages And Disadvantages
Many business owners choose sole proprietorship advantages over those of other legal structures.
It is the simplest and most common form of business ownership. It’s a business owned and operated by one person responsible for all aspects of the company, including its debts and liabilities.
The truth is that this structure might not be for everyone.
Read on to learn about its pros and cons and whether it’s the right choice for you!
|Table of contents|
|1. What is a sole proprietorship?|
|4. What business formation is best for you?|
|5. Frequently asked questions|
What Is A Sole Proprietorship?
A sole proprietorship is a type of unincorporated business entity owned and operated by a single individual. Sole props do not have partners who own the business with them.
In short, is a business owned by one person.
This type of legal formation is relatively easy to start up and maintain and does not require many licenses or permits.
Although the most common form of business organization is the S corporation, sole proprietorship business alternatives are better for many situations.
Many small businesses, such as home-based or freelance businesses, are sole proprietorships.
Understanding more about the pros and cons of the sole proprietorship structure is an investment more than worth making.DBA VS. SOLE PROPRIETORSHIP VS. LLC VS. CORPORATION
Sole Proprietorship Advantages
They Are Simpler To Start And Maintain
Starting to conduct business can be as simple as filing a single document to notify the government that you are running a business. That makes sole proprietorships by far the simplest legal structure to use to set up a business.
On top of that, there is little to do to maintain sole proprietorships once they are up and running. Depending on your situation, all you might have to do is renew your business registration once per year or every few years.
Owners Keep Complete Control Of Their Business
Many sole proprietors prefer their legal structure because they get to hold on to maximum control of their business.
- Without any partner, they get to make all of the decisions on their own.
- Without a corporate structure, they are not beholden to anyone else.
As a result, they do not have to justify to any other person why they choose to do what they do as a business.
The Formation Enjoys Simpler Taxes
Sole proprietor structures are also easier to manage come tax season.
In fact, filing taxes for a sole proprietorship is often no more complicated than filing taxes for an individual.
As a “pass-through entity,” these formations report business and personal taxes like they’re one and the same.
On top of that, many sole proprietors can figure out how to file taxes without professional assistance.
While corporate taxes can be so complicated that a tax professional is necessary, many people can figure out sole proprietorship taxes without accidentally breaking the rules or incurring fees.
Of course, that doesn’t mean that this is always the wisest choice.
In many cases, sole proprietors still benefit from the help of accountants.
In particular, accountants can help sole proprietors identify available business deductions and credits. They may also help you identify other opportunities to benefit from incentives or government programs.
Sole proprietors who manage their taxes on their own often end up leaving a lot of value on the table.
They Are Subject To Fewer Fees And Regulations
Sole proprietors do not need much regulation. They succeed or fail based on their decision-making, so there is no need for them to receive outside guidance.
In contrast, partnerships and corporations are subject to a longer list of fees and regulations than sole proprietorships.
This makes sense when you account for this business entity’s more complicated decision-making procedures.
The government needs to set rules to keep business partners or corporation members from fighting in unproductive or fraudulent ways.
Sole Proprietors Do Not Have To Get A Business Checking Account
They do not necessitate a business checking account.
Many sole proprietors use their personal bank accounts to manage their personal and business affairs. However, doing so often leads to confusion.
Come tax season, it can be challenging to tease apart which transactions you should file as personal and which as business transactions.
At the same time, that is a decision up to the sole proprietor. If you don’t want to create a separate business bank account, no law will force you to.
Although it is permissible for a sole proprietorship not to have a business checking account, it may not be wise.
Sole Proprietors Receive All Business Income And Profits
One of the most significant sole proprietorship pros is that the business owner receives 100% of the business’s profits.
- do not have to split them with any partner
- don’t have to leave them under the control of a corporation
- do not have to limit how they spend them
An individual sole proprietor treats business profits however they want and spend them on whatever they want. They are their personal property.
This Business Structure Makes It Easy To Protect Business Names
Some sole proprietors do not even have to name their businesses. Instead, they may operate using their full name as a substitute for a business name. In such cases, sole proprietorships do not have to register a business name.
However, registering an official business name as a sole proprietorship can protect your business name. That does not make a big difference for every sole proprietorship. However, it is still a practical option to have on the table for many sole proprietors.
Having a DBA is a great idea.
They Can Hire Unlimited Employees
Many people get the wrong idea about sole proprietorships and assume that they cannot hire employees. However, that’s not true.
There is no limit to the number of employees a sole proprietorship can hire.
The term sole proprietorship refers only to the singular control of the business. It does not indicate that the company’s owner has to perform business operations independently.
Sole proprietors are as free to hire employees and contractors as other business structures.
Sole Proprietorship Disadvantages
Owners Do Not Receive Liability Protection
A business owner with a sole proprietorship will always be legally liable for the business debts.
To understand this disadvantage, we must explain how another business structure handles liability.
The acronym LLC stands for limited liability company.
The invention of the LLC allowed many people to own partial ownership of a venture and coordinate their decision-making for maximum results.
Even better yet, the owners of corporations have liability protection: they are not personally liable for the company’s debts.
Of course, if a company does poorly and ends up owing individuals and businesses a lot of money, it may go bankrupt. But at the end of the day, the corporation owners are not required to pay for the corporation’s debts out of their own pockets.
That is true for the business’ owners, operators, executives, or managers.
But what does that mean in practical terms?
Among other things, when a sole proprietorship goes bankrupt, their owner’s credit score will suffer considerably for many years. Creditors may even come after their personal assets.
In contrast, when a limited liability corporation goes bankrupt, it does not affect the credit scores of the owners or executives.
These Businesses May Struggle To Get Financing
Many sole proprietorships struggle to receive financing.
Usually, this is because most owners do not own many business assets. As a result, they have little in the way of collateral to provide to banks or other institutions that might lend them money.
Some see the simplicity of sole proprietorships as an indication of a lack of due diligence or less professionalism.
Many sole proprietorships decide it is worth changing their business structure after facing a long series of failures to raise capital to build their business in the way they dream.
Sole Proprietors Stay Tied To Their Businesses
Sole proprietors have a more challenging time taking a break from a sole proprietorship business.
Because the business and the owner are one and the same, the owner can’t really step away from the company without essentially shutting it down.
This can make it difficult to take vacations or even weekends off, as there often isn’t anyone else who can step in and handle things in the owner’s absence.
If you do find someone to manage it while you’re gone, you can still put yourself at risk. Whatever happens with your business, you will be entirely responsible.
For example, if a manager decides to take a risky decision while you’re gone, you will still be liable for any debts or issues.
Also, if the owner becomes incapacitated or dies, the business usually goes with them.
This can be a significant downside if the owner has spent years building up the business and wants it to continue after they’re gone.
They Can Be Stressful, And Hard To Grow
Many people start a sole proprietorship and do not see any problems initially. However, constant responsibility, complete control, and potential liability can build up over time.
The owner is solely responsible for all aspects of the business, including:
- Customer service
This can be a lot of work, and it can be challenging to do everything well. There might not be anyone to turn to for help or advice—you are on your own.
Many sole proprietors end up closing their businesses rather than dealing with the constant pressure of such an unforgiving legal structure for their business.
And while these businesses can be profitable and generate a good income for their owners, there’s only so much money that one person can make.
The business will never grow beyond the owner’s ability to run it, so there’s a natural limit on how big the company can get.
What Business Formation Is Best For You?
In 2018, the National Small Business Association revealed that 12% of small businesses were sole props. In contrast, about 35% of companies use the LLC structure, and 33% use an S corporation structure.
Considering all of the advantages we have discussed, why so few businesses are sole props?
There are several reasons why businesses might choose to avoid the sole proprietorship structure. But the first one is probably growth. Entrepreneurs that want to grow change to other business structures.
That doesn’t mean that staying a sole proprietor is bad, especially if your business is new or if you don’t have the resources to make it grow (just yet).
Sole proprietorships can be a great way to get your business off the ground.
But if you eventually want to grow, you can consider getting funding through an online lender. Once you have the resources to do so, changing your business structure might make sense.
Applying for a loan as a sole proprietor is easy with Camino Financial. We don’t require collateral, and our application is quick and painless.
A loan could give you the boost you need to grow your business.Apply now!
Should I switch from a sole proprietorship to an LLC or corporation?
If there is a significant risk that your business will incur serious debts, it is almost always a good idea to set up an LLC or an S corporation.
A few advantages to a sole proprietorship can make up for exposing your personal assets to such risks.
Keep in mind that if a sole proprietorship cannot pay back its debts, creditors can legally come after the sole proprietor’s personal assets.
What does “sole proprietor” mean?
“Sole proprietor” is the term for a business that does not have any other owner. You can think of a sole proprietorship as an extension of the sole proprietor. There is no separation between the business and the individual who owns it.
Can a sole proprietor have employees?
This business entity can hire employees and contractors as any other small business. There is no limit to the number of employees or contractors they can employ.
How do taxes for sole proprietors work?
Sole proprietorship taxes tend to be simple. The assistance of a tax professional can help a sole proprietor diminish their tax liability. But it is often not necessary to successfully file tax forms.
Does a sole proprietor need an EIN?
Sole proprietorships need an employer identification number if they have any employees. If not, the sole proprietor can use their social security number instead of an employer identification number.
However, if they hire an employee, they will need to get an EIN.
How do you change from sole proprietor to LLC?
All a sole proprietor needs to do to set up an LLC is file articles of organization and the other standard forms. They may also need to obtain a business checking account and necessary business licenses and permits.
Nothing about starting as a sole proprietorship makes the normal process more difficult.
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