You are at the beginning of a new adventure – that’s great!You are at the beginning of a new adventure – that’s great! As a business owner, you may be wondering about the sole proprietorships, especially at start-up stage. Finding the right information can be challenging. We are here to help you answer these questions.
What Is a Sole Proprietorship?
Are you interested in launching a business, but you are not fond of paperwork? Then consider doing business as a sole proprietorship. Because of its simplicity and affordability, this is one of the most common types of informal, one-owner businesses. The only thing you have to take care of before you start making a profit is to proceed with the deals!
Unlike an LLC or corporation, a sole proprietorship does not create a separate legal entity. In fact, the owner of a company acts as a business entity and is legally inseparable from an enterprise. It means that the owner not only manages the venture independently but is also fully responsible for the company’s obligations.
Advantages of a Sole Proprietorship
These days, the popularity of a sole proprietorship is unquestionable. Along with LLCs, a sole proprietorship is in high demand among aspiring entrepreneurs. The main reasons why people choose a sole proprietorship are as follows:
- Availability: Unlike other business structures, such as an LLC and corporation, the process for creating a sole proprietorship is quite simplified. You don’t have to register, fill out lots of different paperwork, and pay expensive state fees. The guidelines may vary slightly from state to state, but, in general, the mere fact of doing business is enough to become a sole proprietorship.
Nevertheless, be ready for the fact that you may have to obtain one or more licenses if the law requires it;
- Ease of maintenance: Whereas formal business entities are obliged to regularly file their reports with the state and the public, sole proprietorships have much more freedom. Such organizations are controlled by only a few state regulations. You don’t have to comply with numerous requirements or file financial reports, as well as annual reports, and waste time and money on paperwork;
- Straightforward taxation: For tax purposes, a sole proprietorship acts as a “pass-through” tax unit. It facilitates the company’s operations since you don’t have to worry about paying corporate taxes. Unlike some other business organizations, a sole proprietorship does not submit a tax return on its own behalf. Instead, the responsibility for paying taxes falls to the owner, who lists the business’s income and expenses on their personal tax returns. That way, you can meet the legal requirements by simply completing and filing Form 1040.
One more great advantage of sole proprietorships is that you can get a tax deduction. As such, you may deduct 20% of your net income from your taxes;
- Control: Being a single owner of a sole proprietorship, you can make all management decisions quickly, without worrying about their approval. All aspects of your enterprise are under your full control.
Additionally, unlike with a corporation, you do not need to create and maintain internal company management bodies;
- Privacy: As there is no need to provide documents for official registration to establish a sole proprietorship, your personal data will not be publicly available. In the process of operation, a sole proprietorship almost never faces any reporting requirements;
- Finances: A company does not pay taxes at the corporate level, therefore, its income is retained in full. You are free to choose how to dispose of the funds you earn, either to withdraw or, for example, to reinvest them in your firm to accelerate its development;
- Ease of change: Many entrepreneurs get started as sole proprietorships because this way of running a business is great for small companies. However, if you want to expand in the future or, for example, form an LLC, you can do that.
Disadvantages of a sole proprietorship
Although sole proprietorships are quite in demanddue to their simplicity and accessibility, this option is not suitable for every business. There are some issues, which prevent us from describing this method of conducting business as the best one. Let’s take a closer look at them.
Sole proprietorships can neither admit a new member like LLCs, nor issue stock like corporations. The business is indivisible and tied to the owner, which makes it difficult to find investors. Most prefer to invest in a more stable formal venture, rather than entrust money to a single individual.
Furthermore, the option of getting a bank loan for the business growth will be also based on the financial history of the proprietor. As a rule, sole proprietorships have no credit cards, as well as separate bank accounts. Thus, the venture depends a lot on the owner’s support. Of course, you are free to raise funds for the company’s future development, but doing so can be risky.
Inability to sell your company
As a sole proprietorship is legally inseparable from the owner’s identity, it is actually impossible to sell or bequeath an organization, except in the form of assets.
The duration of this type of business venture is also limited. Sole proprietorships may operate only during the owner’s lifetime, or until they decide to close the company.
In contrast to partnerships, sole proprietorship activities are completely under a single owner’s control. A sole proprietor is fully in charge of all managerial issues and determines the direction of business development. Even if you hire a manager, it can still be difficult to take a vacation because many issues require the owner’s personal attention. As a company grows and expands, this obligation and restriction can be somewhat uncomfortable.
Lack of personal property protection
Due to the fact that a sole proprietorship is not a separate legal entity, its debts and liabilities are considered to be those of the owner. It creates unlimited personal liability, which can cause heavy financial costs if the company’s activity involves significant risks. The same thing applies in the case of a loan. If you fail to pay back the debt or repay it, the company’s creditors have the right to claim your personal assets. Your house, car, and money will be at risk in such a situation.
These things make sole proprietorships not the best option for large companies with an extensive client base and significant profit margins. If you plan to grow quickly, or if you anticipate that your business may be sued, then it might be worth considering an LLC or corporation formation. Both of these business structures offer limited liability protection.