Sole proprietorship vs. partnerships is a common and valid debate that business owners have when choosing the legal structure for their new companies.
Many small business owners face tough decisions when starting a business. Will they start the company alone, or will they seek others to help in their venture?
This article will dive into the sole proprietorship vs. partnership dilemma. We will explain the differences unique to these business structures and discuss the pros and cons of each.
What is a sole proprietorship?
A sole proprietorship is a one-person business that doesn’t have to register with the state. Unlike partnerships or another business structure (corporation and limited liability company).
If you are the single owner of a business, you are, by definition, a sole proprietor.
Advantages of a sole proprietorship
A sole proprietorship is one of the most common types of small business due to the many benefits.
- It is the easiest type of business to start since most states do not require this type of company to register with their Secretary of State.
- There are fewer regulations about having a board of directors (since it will just be you) and recorded meetings.
- Another obvious bonus is that you have no one to answer to but yourself; you’ll also have the ability to set your work schedule and routine.
- You also don’t have to share your profits with anyone (unless you hire employees, in which case you’ll have to budget to pay for their salaries).
Disadvantages of a sole proprietorship
- The biggest problem with sole proprietorships is that the business owner’s and the business’s finances get mixed up.
- You have personal liability, so any lawsuit against your business is also brought to you. This means you will also have to be liable for all the fees and costs in litigation for your company.
- You are responsible for paying income and self-employment taxes on all business profits. This means that as the business becomes more profitable, you will owe even more in taxes.
Types of sole proprietorships
A sole proprietor operates a business single-handedly. They run the operation, maintain business assets, and ensure debt doesn’t escalate.
There are three types of sole proprietorships.
- Self-Employed. You’re the boss from start to finish; however, you can hire employees. Being self-employed means, you’re in charge of job security because you decide how long you’re in business. Also, there are numerous tax benefits you can claim when filing your tax return.
- Independent Contractor. This sole proprietor is a specialist in their field of expertise and works typically for one or more clients. They receive lump-sum payments with no payroll taxes withheld and receive 1099 each year itemizing what they earned.
- Franchise Owner. A franchisee pays the franchisor money for a license to use an established brand. Plus startup fees and costs and an ongoing revenue percentage. They enjoy the benefits with an established branding and receive continuing support.
What is a partnership?
A partnership is a business entity formed by an agreement between two or more individuals to carry on a business.
Each partner is an owner and has separately co-invested in the business. A partnership is different from a corporation because it is not separate from the individual owners.
In that sense, it’s more like a sole proprietorship. Because, in both, the business isn’t separate from the many owners for liability purposes. Also, don’t forget that are many types of business under the umbrella of partnerships.
Learn here all the types of legal structures for businesses.
Advantages of a business partnership
- While partnerships have to pay taxes on profits made, you don’t pay separate taxes for being self-employed as an owner.
- Partnerships can also be very fruitful due to each partner’s added knowledge, skills, and experience.
- Lastly, although they are more complicated than sole proprietorships, partnerships are easy.
Disadvantages of a business partnership
- One of the worst parts of a partnership is that you can be responsible for something someone else has done. In one case, the courts can seize the assets of all the partners to do reasonable damages.
- There can also be some incredibly tricky situations when one partner wants to dissolve the business and the others don’t.
- While you may not pay as many taxes in a partnership, you are still legally and somewhat financially tied to your partner(s).
Types of business partnerships
There are five types of partnerships.
- General Partnership. One or more partners equally own the assets and liabilities of a company, pay its debts and generate profits. Each partner is responsible for the business’s success and may use their personal assets to pay for business debts.
- Joint Venture. This type of partnership normally operates using an agreement designating a specific date to end the joint venture. Contracts can be between individuals or business entities that pool resources for a business purpose.
- Limited Partnership. Partners have equal but limited liability that matches their initial investment. They do not actively manage the business.
- Limited Liability Partnership. Predetermined or fixed is this type of responsibility of each owner. So creditors cannot access the person’s personal assets or income.
- Limited Liability Limited Partnership. One general partner and limited partners are not subject to personal liability for the business. Not every state recognizes this reasonably new business structure as a legal entity.
Positives and negatives aspects of sole proprietorship vs. partnership
Total profits for the owner
|No Self-Employment Taxes|
Financial dependence on partners
Is a sole proprietorship better than a partnership?
It depends on your point of view and your goals, vision, and needs.
Since you are the one owner in a sole proprietorship, you have complete control over your business aspects. You have the freedom to make all crucial decisions, and all the business profits are only yours.
However, this comes with a greater risk. A sole proprietorship bears unlimited liability, meaning that you are responsible for any losses. Sole proprietorships usually have less credibility from potential investors or lenders.
However, go for a sole proprietorship if you can’t find reliable partners, keep things simple, or want complete control of your business.
How do you establish a sole proprietorship or a partnership?
So, now you’ve understood the differences between sole proprietorship and partnership, and you’ve decided which entity type works best for you. Here, you’ll find how to establish a business in your chosen structure.
Establishing a Sole Proprietorship
There aren’t complicated startup requirements for establishing a sole proprietorship. You don’t have to take any formal or legal steps at the federal, state, or local level.
However, there may be local registration, business license, or permit laws you need to comply with to make your business legitimate. All these may differ depending on your estate. You will need to contact your nearest Small Business District Offices (SBDC) to ask for those specific requirements.
File a trading name (a fictitious name), also known as DBA (“Doing Business As”). A DBA will allow you to legally do business under that name instead of your personal name. Find out here if you need a DBA for your business. These days registering a DBA is easier than ever: you can do it online using LegalZoom.
Lastly, you also need to know about your income tax and business debt obligations. Because, as a sole proprietor, you are personally responsible for paying these debts.
Establishing a Partnership
The process is more complicated than in a sole proprietorship. These are the steps to follow:
Register the business
You need to register your business with your state before it starts operating. This, you usually do through your local Secretary of State office.
Establish the business name
The business’s legal name is either the name given on your partnership agreement or the partners’ last names. If you’d like to operate under a name other than the business’s legal name, you’ll need to register a DBA (same as in a sole proprietorship).
Obtain licenses and permits
The regulations for licenses and permits vary by industry, state, and locality.
Create a partnership agreement
This is not legally required, but it’s safer to have one. Discuss with your partner(s) how you will make decisions, how you will divide profits, how you will resolve disputes, how to change ownership, and how to separate the business structures.
How do you dissolve a sole proprietorship or a partnership?
When evaluating which business structure is best for your business, you must know the aspects of dissolving both organizational structures to make the best decision.
Dissolving a Sole proprietorship
You must notify the IRS and state and local tax authorities that you no longer operate the business. Also, keep records of final tax forms and close business accounts, so interest does not accrue.
Dissolving a Partnership
Your partnership agreement should include a dissolution clause or terms of dissolution. This document consists of specific dissolution procedures to the partners for specified situations.
In addition, you should check your state’s business laws, as state law governs partnership separations. The State Secretary’s office or website will help you with the process of dissolution (fees, forms, etc.).
Lastly, you will need to file a declaration of dissolution (sometimes known as a certificate of cancellation) with your state. It can take up to 90 days from the date you file the statement of dissolution for your partnership to dissolve.
Keep reading: DBA vs. Business License
Sole proprietorship vs. partnership taxes
Filing Taxes as a Sole Proprietorship
As a sole proprietor, you must report all business income and financial losses on your personal income tax return. The government does not separately tax the business. The IRS calls these “pass-through” taxes because business profits pass through the company to your personal tax return.
Filing Taxes as a Partnership
As a business, a partnership does not pay income tax.
A partnership is also a “pass-through” entity. Profit and losses are the partners’ responsibility to include within their personal income tax returns.
However, you need to file an annual information return (Form 1065) to report the business’s financial aspects.
How do you get a business loan as a sole proprietorship or partnership?
Getting a Business Loan as a Sole Proprietorship
Usually, it’s easier to get a personal loan for sole proprietors than a business loan. You can use a personal loan for eligible business purposes.
To get approved, lenders will base their decision on your personal credit history and income. Keep in mind that personal loans usually aren’t very high.
If you need more funds, you can also get a loan. In this case, you will require proof of your DBA registration. Keep in mind that the business loan requirements vary from lender to lender, as well as the type of documents you’ll have to provide.
Camino Financial is a lender option that offers individual or small business loans. Their requirements are less stringent than conventional banks, and their process is quick and easy.
Getting a Business Loan as a Partnership
Again, the requirements will depend on your lender and the type of loan you need. But something will remain the same no matter what lender you approach: you’ll have to provide proof of your business structures.
In the case of a partnership, you’ll need to provide your business partnership agreement. This helps to establish your ownership of the business.
Remember that your lender wants to be sure that they are dealing with the correct person when appraising your loan application.
Differences between sole proprietorship and partnership
Financing loan sole proprietorships and partnerships
Whether you’re a sole proprietorship or a partnership, consider taking out a loan from Camino Financial if you need an infusion of cash.
We are more flexible than traditional lenders regarding our requirements. Mainly, we consider the business owner’s personal credit and global cash flows.
Camino Financial is open to extending finance to borrowers with bad credit, among other benefits. You don’t have to provide us with collateral.
These are the only documents we require from you:
- Your online application
- Last year of tax returns with reported business income (remember that you have to report taxes regardless of the legal structure of your business!).
- Proof of business registration (DBA registration or partnership agreement depending on your type of business).
All you have to do to start is submit your loan application. It will take only a few minutes, and you will receive an instant response informing you if you are in the prequalification stage.
Subsequently, one of our representatives will contact you and guide you through the borrowing process.
Sole Proprietorship vs. Partnership: FAQs
What are the benefits of a sole proprietorship over a partnership?
These are the main benefits of a sole proprietorship over a partnership:
Can a sole proprietor have a partner?
As a sole proprietor, you may have employees, but the moment you agree to do business with someone else, it’s not a sole proprietorship anymore.
Even without a written partnership agreement, you can turn your sole proprietorship into a legal partnership. However, having a formal partnership agreement is your best choice.
Can a sole proprietorship become a partnership?
Yes, and it’s simple. The moment you agree to do business with someone else and share profits and losses, you have turned your sole proprietorship into a partnership, even without a written partnership agreement. However, writing a partnership agreement and legally structuring your business is highly recommendable.
How do you convert a sole proprietorship into a partnership?
If you are a sole proprietor of a business and have decided to share ownership with another party, you can convert the proprietorship into a partnership.
All proposed owners must contribute to and agree with this document to form an official partnership.
It would help if you discussed, among others, includes the ownership percentage split (such as 60-40 or 70-30), partner responsibilities, etc. You must both agree on all points to form the partnership. Then, follow the steps indicated above.