When starting a business, one of the first things you need to do is elect the appropriate structure. Many of the small businesses in the US are sole proprietorships as these are the simplest ventures to set up. That said, it’s important to weigh all of the sole proprietorship pros and cons before deciding whether you want to be solely responsible for both the assets and liabilities.
What Is Sole Proprietorship?
A sole proprietorship is also known as a sole tradership or simply a proprietorship. It is an unincorporated business with a single owner who pays personal income tax on any profit that the business generates. As such, the owner is relieved of any specific business taxes or corporate tax payments, and no double taxation is possible with this model.
A sole proprietorship is one of the simplest businesses to set up because it is owned and operated by a single proprietor and the legal requirements are minimal. This is a very popular option among entrepreneurs who are looking to start a business on their own and conduct all the transactions under their own name.
Pros of Sole Proprietorship
There are several key advantages to starting a sole proprietorship, including:
- Complete control of the business
- The fact that this business structure is easy to establish
- The absence of corporate business taxes
- Very few legal and formal business requirements
In a sole proprietorship, a single person has complete control over the business. As a sole proprietor, your decisions determine the trajectory of the company, and you don’t have to consider the opinions of third parties such as shareholders or legal partners.
This is a level of freedom that isn’t afforded with other business types, such as an LLC or a C-corporation. The unprecedented level of control and the freedom to maneuver are the main reasons many young entrepreneurs choose this type of business structure. It allows the owner to experiment with different ideas and concepts before choosing the best approach.
In other words, a sole proprietorship enables business owners to take a certain degree of risk and test out their ideas before adopting a more formal business structure. Sole proprietors also receive all the profits and are free to sell or transfer their company to another person anytime they want.
Easy to Set Up
Establishing a sole proprietorship is a remarkably simple process. One of the main advantages, when compared to other business structures, is that you don’t have to fill in a pile of paperwork in order to get started. Other business types require you to register with your state government before you are legally able to operate as a company. However, you don’t have to register with the state when setting up a sole proprietorship, and you don’t have to worry about the considerable costs that come with starting LLCs, for example.
The most important thing is to secure the relevant business licenses and permits. This is determined by the state, city, or county in which your business operates. A quick chat with the nearest Small Business Development Center will tell you everything you need to know. If you need any additional assistance, there are fairly affordable legal services to choose from.
This may sound like a time-consuming affair, but it’s a faster and simpler process than setting up another type of corporation in which assets are shared.
Few Formal Business Requirements
Business structures such as S-corporations and C-corporations aren’t only costly to set up but require extensive operational processes and record keeping. The unique structure of sole proprietorships frees your business of these requirements. Essentially, you can make your own rules as long as you’re legally compliant with local regulations.
For example, a sole proprietor can skip all the meetings that are organized within LLCs to make sure all their members are on the same page and happy with the way things are running. Some companies need to have business decisions formally approved by their board of directors rather than by a single person. Such constraints don’t exist within a proprietorship.
Businesses that have shareholders often hold votes when appointing managers and new members. This is the case with any formal action the company takes, and minutes for all of these meetings and votes need to be kept for corporations. Of course, a sole proprietor is making all the decisions for their business entity.
No Corporate Business Taxes
The federal corporate tax rate is 21% of business profits. A sole proprietor doesn’t have to make corporate tax payments and only pays a personal income tax. Any earnings from this business should be claimed as pass-through income. This means that you report the income of your business on your individual income tax returns.
C-corporations have their revenue taxed as a company but also get taxed a second time when profits get distributed to shareholders as dividends. In other words, the corporation is being subject to double taxation, something that sole proprietors don’t have to concern themselves with.
The taxes that you should expect to pay as a sole proprietor are as follows:
- Self-employment tax
- Income tax
- Sales tax
The self-employment tax is imposed on those who run their own business. This is relevant for any income from the business and ranges between 7.65% and 16.2%. As a sole proprietor, you’re required to list all profits on your personal tax return, which will be taxed at your ordinary rate.
A sales tax doesn’t apply to all sole proprietors as it depends on the nature of the business. If you sell any kind of goods, you are subject to a sales tax. This also depends on the state that you are in, so be sure to familiarize yourself with local state laws before sorting out your taxes.
Cons of Sole Proprietorship
This business structure also has its share of disadvantages. Below are the most important ones:
- No liability protection
- Personally responsible for all business debts
- Perceived lack of professionalism
- Hard to sell
No Liability Protection (Unlimited Liability)
Companies that are registered with the state get a certain level of liability protection due to the fact that they are legal business entities. As a sole proprietor, you are responsible for all the debts and liabilities linked to your business. Unlike the benefits enjoyed by other businesses, the government considers the sole proprietor a self-employed individual, which means that you are on your own.
To put this into perspective, an LLC offers protections that prevent creditors from being able to seize the personal assets of the business owner if things don’t work out. It also shields the business owner from potential lawsuits related to the business. There are a few exceptions to this rule in very rare circumstances, but generally, the protection afforded to owners is extensive.
If you are a sole proprietor, these protections do not apply to you. And if a customer is unsatisfied with the services of your company, you are the only one held liable.
Personally Responsible for All Business Debts
All of the obligations of the business fall squarely on the sole proprietor. This includes any debts for which the sole owner is held personally liable.
Other businesses have a certain level of protection here as any financial or legal issues are that of the business itself, not the person who owns the company. Unfortunately, these protections do not extend to sole proprietorships.
Perceived Lack of Professionalism
As a sole proprietor, you will face a lot of stumbling blocks. For starters, in the business world, sole proprietors are often perceived as people who lack professionalism as they are not registered with the state. Sole proprietors often work from home and run small businesses in order to make some extra income, rather than trying to build a large and globally recognizable company. Of course, more often than not, these perceptions are inaccurate, and there is nothing wrong with this kind of business setup.
To avoid any misconceptions as a sole proprietor, you can obtain a “doing business as” name. Where most sole proprietors just trade through their name, a DBA can help eliminate any perceived lack of professionalism. You should also open a business bank account in this name, and all your transactions should have this name attached to them rather than your personal name.
Harder to Sell Down the Line
A sole proprietorship has its share of benefits. However, complications can arise when you’re trying to sell your business. Since the company is tied to you as an individual, it is difficult at best to sell this type of business. As such, if selling the business down the line is an important part of your plan, then this is not the best business structure for you to consider.
That said, it isn’t impossible to sell this type of company. It is simply more complicated because you need to sell your business assets rather than the company itself. While you cannot sell the company as a whole, you can still sell parts of this entity. The buyer will have to change the business name unless you have already established a separate “doing business as” name. If you have, then you simply need to give the new owner legal permission to use the name.
What Are Your Other Options?
Sole proprietorships are far from being the only avenue worth exploring in the business world. They’re probably not a good choice for anyone who wants to develop a vast business network or needs extensive resources. If you’ve given yourself permission to think big, you might want to consider other options.
For example, if you still plan to be the only person involved, it’s possible to convert your business to a single-member limited liability company or an SMLLC. This would give you some limited liability protection and tax benefits, so your assets aren’t exposed to a certain level of risk. If you need help opening an LLC, you can hire an LLC service company to help you get started.
Of course, LLCs have their own disadvantages, including extra costs, so make sure you have the right budget for your preferred venture.