The Sole Proprietorship Advantages and Disadvantages You NEED to Know


What is a Sole Proprietorship?

To put it simply, Sole Proprietorships are business entities owned and managed by a single person. Even though there’s a single owner, there can be employees working within the business. If you are married you can make what is called a Co-Sole Proprietorship with your spouse. Sole proprietorships are the simplest of business entities.

The owner (sole proprietor) is also the operator of their business. The owner is fully responsible for anything having to do with the business and gets all of the profits. The business owner is in direct control of all of the business’s movements.

At the same time, the owner is responsible for any debts or legal issues should they arise. If the business itself can’t deal with these problems, lawyers and banks will come after the owner’s personal property and assets to cover what is owed. They can take anything that is yours like investments, savings, houses, cars, real estate, etc.

Business entities like Partnerships, Corporations, LLCs are different from Sole Proprietorships. In a Sole Proprietorship, the owner is “solely” in charge and responsible for any good or bad the business does. In the other entities mentioned other people control/operate the business like other owners or members and shareholders.

In LLCs and Corporations, your personal belongings are protected if the business takes on debts or faces legal troubles since these entities provide liability protection. These protections apply to the owners and shareholders of LLCs and Corporations. They do not apply to Sole Proprietors, who are personally liable for any debts and lawsuits. LLCs and Corporations protect personal assets. Sole proprietorships do not.

Sole proprietorships are the easiest business entity to create. It won’t cost you anything to form one either. A business entity of this sort is established just by the owner beginning operations of his or her business. There aren’t any licenses or registrations necessary for creating a Sole Proprietorship.  All you have to do to get started is get any special licenses or permits needed for your specific business to operate. Once you have the business in operation, that’s it. You’ve got yourself a Sole Proprietorship.

It is easy to dissolve your sole proprietorship too because it only remains running as long as you’re running the business. As soon as you stop operations, the business ceases to exist. This can be through a sale of the business, the death of the business owner, or by simply closing the business.

You will be in total control of your business. More control than some other business entities (Partnerships and Corporations). A lot of entrepreneurs start their business out as a Sole Proprietorship and then re-form them into LLCs, Partnerships, or Corporations later on as the business is built.

Information regarding how to collect your profits and pay your taxes in a Sole Proprietorship follows the Pros and Cons lists.

It’s important for anyone thinking of going this route to speak with a lawyer or financial advisor before making major decisions. It is important to know what you’re getting yourself into and what is required of you in the different business entities and depending on which state you’re going to operate in. For example, some products and services need special permits and licenses to be sold in certain states.

If you want to use a DBA (Doing Business As…) a.k.a. Fictitious name, you’ll need to register it in most states. A fictitious name or DBA is any business name that isn’t identical to your legal name. Registering a DBA is done through your local county clerk office or your state government, depending on which state you’re doing business in. Some states don’t even need you to register a DBA. If you will be doing business in multiple states you’re going to go through the Department of Commerce in Washington, D.C.

DISCLAIMER:

“Business Initiative” is for general educational purposes only. “Business Initiative” does not offer any legal or financial advice. Anyone considering starting a business should speak with a lawyer, business professional, financial advisor, and tax expert before making any binding decisions when it comes to starting, operating, and growing your business. External resources should be used independently of “Business Initiative”. It is the responsibility of every reader to seek legal and financial advice from legal and financial professionals

Advantages of Sole Proprietorships

The Pros of Sole Proprietorships include:

- Simple to Create

It’s easy to form a Sole proprietorship. All you have to do is get the business moving (and be the only one in charge of it). Since there are very few restrictions and forms involved in establishing a Sole Proprietorship, you can quickly get the business up and running.

There’s also the bonus of not having to pay yearly business registration fees for the Sole Proprietorship. You don’t even have any registration fees in the first place. This is a benefit that LLCs and Corporations don’t receive. They have to pay registration and filing fees and then, pay those fees every year to keep things running. “The cost of doing business” as it’s called.

- Maximum Ownership and Control

You will have total control over the profits of your company. As the owner, you control and own everything. In a sense, by being a Sole Proprietor, you are the business.

It is easy to hire (and fire) employees using this business structure. You don’t need approval for decisions from other members or shareholders because there aren’t any.

You will have the ability to make decisions and changes to the business on a day-to-day basis. The power is in your hands. Maintaining a Sole Proprietorship long-term isn’t a problem if you know what you’re doing. You can take the business in any direction you please (for better or worse).

One thing that comes with all of this control is not having to disclose and report everything to the government. This is privacy is an advantage over LLCs and Corporations who are required to keep everything up-to-date and accessible to the government.

- Quick Dissolving Process

It is easy to get out of the business when you pretty much are the business, in the case of Sole Proprietorships. All it takes to “close the doors” is for the owner to stop operations, sell the business’s components, or by dying. Pretty simple.

- Single Taxation

In most states, there is no need to file taxes separate from your regular personal tax returns. All you would have to do is report any profits made or losses from the business on your personal income tax return.

This is a major advantage over the average corporation which receives a thing called double taxation. Corporations get a corporate tax, on all profits first and then, once everybody gets paid out, everyone pays their personal income taxes.

Sole Proprietors only have to pay individual tax rates on whatever they/their business is making. You don’t need an IRS employee identification number (EIN) as you would for state-registered business entities. You can get one if you want to but they aren’t necessary at all.

Having employees can provide tax benefits since paying employees counts as a business expense if certain criteria are met.

- Almost No Paperwork

There aren’t any business licenses required to begin operating a Sole Proprietorship. There’s hardly any registration paperwork for this sort of business. Only under special circumstances do you have to register with your state. You are the business in a Sole Proprietorship.

All it takes for you to become a Sole Proprietor is to do business and cash that check. With everything relying on you, there will be less government control over your operations.

Being the owner of a Sole Proprietorship, there is no requirement to keep incorporation records and annual corporate records. You aren’t required to keep a balance sheet either. You just have to be willing to deal with the consequences of whatever decisions you make. The same goes for life.

The only real forms and requirements depend on what you are providing. Some products and services need licenses and permits to be sold. This is on a case-by-case and state-by-state basis.

Disadvantages of Sole Proprietorships

The Cons of Sole Proprietorships include:

- Liability

Conducting business as a Sole Proprietorship means you will be personally liable for your business’s debts, legal problems, taxes, and decisions. This means the risk is increased for all of the business’s decisions and activities since all of the responsibility lies “solely” on you, the owner.

Sole Proprietors don’t receive the benefits that come with state-registered businesses since they don’t register with their state. The legal protections associated with LLCs and Corporations don’t apply to Sole Proprietorships.

LLCs are called limited liability companies because the owner(s)’s personal assets and belongings are protected. Sole Proprietors have this added risk if problems do happen to arise.

If something goes down and the business can’t afford to remain operational, creditors (people or entities your business owes money to) have access to your personal accounts, assets, and even property to pay for what’s owed. This is only if your business can’t cover it on its own first. You are personally liable.

For these reasons, it may be a good idea to get special insurance to cover injuries or physical losses which have the potential to cease operations.

- Functionality

Let’s say you want more people to join in on owning parts of your business, you wouldn’t be able to keep it a Sole Proprietorship. If you want other owners or shareholders involved you have to first dissolve the business entity of Sole Proprietorship and reform it as a Partnership, LLC, or Corporation.

The only way two people can be heading the operations of a Sole Proprietorship is if they are married. This is known as a Co-Sole Proprietorship.

Another thing to keep in mind is if the owner leaves the business or dies, the business simply dissolves. In a Sole Proprietorship, the owner is the business. If the Sole Proprietor isn’t able to run the show, the Sole Proprietorship they created gets destroyed. Without the owner, there is no business. Company assets, profits, and property all follow the owner.

In the event the owner dies, anything of value that goes to the family or anyone written in the will of the owner will undergo Inheritance Tax. This automatically lowers the value moving into the inheritors’ hands.

- Difficult to Get Funding

To initiate the business, you have to pay for everything yourself. You are unable to receive outside investment income to begin operations. Funding is dependent on your investments, credit history, and financial background. You also can’t decide to issue stocks/shares for the Sole Proprietorship later on.

Attaining additional loans can prove difficult if you don’t have high enough credit. Personal loans are also risky for Sole Proprietors. Taking out a personal loan means you’re putting your assets on the line if things turn sour and the bank wants their money back. They can come after your personal property.

Banks want to work with established companies who have been in the “business” of being a business and have a strong credit history. Sole proprietors cannot build business credit because Sole Proprietorships aren’t seen as business entities financially. This means the owner can’t get business credit cards and bank accounts.

You do have the option of registering a DBA for your Sole Proprietorship. By doing this, you will be able to open a business checking account at your bank. This does require that you fill out some paperwork and supply the bank with a certificate of DBA once things are official.

There’s another thing to keep in mind before getting right into business. This little thing is called Self-Employment Taxes. Self-Employment Taxes consist of Social Security and Medicare Taxes. These have to be paid in addition to the regular Personal Income Tax.

Before making binding financial decisions, it is recommended that you speak with a CPA, a Certified Public Accountant.

- Difficult to Sell

It was mentioned earlier that the ways out of a Sole Proprietorship include: death of the owner, selling the business, or ceasing operations. This is mostly a disadvantage because someone else can’t just come along and pick up where the original owner left off. Selling a Sole Proprietorship is not a simple task.

It is nearly impossible for you to sell or pass your business over to someone else. Now, to be clear it’s only nearly impossible to sell, not completely impossible. You have the option to break the business up into its assets and sell those.

You cannot just sell the business as a single entity. Remember, in a Sole Proprietorship you, the owner, are the business. You are the entity. You cannot pass over the name because it’s your name. This is the case unless you have a registered DBA (“doing business as” name) and you sell/transfer that name over to the buyer of your business.

All of this is to say that you can sell or transfer a sole proprietorship if you really want to but it is much more complex than selling or transferring a business entity that is officially registered and recognized.

Sole Proprietorships are great if you seek total control over your business, but not so great if you want to eventually transfer that control over to someone else.

Sole Proprietorship Income and Taxation

Sole Proprietorship income is treated as if it were any old personal income.

The owner of the business will just have to declare their income on a standard 1040 Federal Individual Income Tax Return Form. All you’ll need to do after filling out your standard 1040 Form is to fill out a Schedule C 1040 Form accounting for all of your Sole Proprietorship’s Profits and Losses information.

After this, you’ll need a 1040-ES Form to determine Self Employment taxes for Individuals (yourself in this case). In a sole proprietorship, you have to submit this last form (1040-ES) quarterly. That means every January, April, June, and September you have to submit the Self-Employment Tax Form to the feds.

Additionally, since you are a sole-proprietor and are fully responsible for all aspects of your business, you have to make sure you are paying Payroll Tax, State income taxes (All states excluding AK, TN, FL, NH, SD, WY, TX, WA, & NV), and maybe even city income taxes if your city has them.

It all may sound complicated and overwhelming right now but be assured it’s not. There is a system to this. Thousands of people have used this system and have become very successful with time.

If you really want something you can make it happen. The only thing standing between you and the life you desire is yourself.

DISCLAIMER:

“Business Initiative” is for general educational purposes only. “Business Initiative” does not offer any legal or financial advice. Anyone considering starting a business should speak with a lawyer, business professional, financial advisor, and tax expert before making any binding decisions when it comes to starting, operating, and growing your business. External resources should be used independently of “Business Initiative”. It is the responsibility of every reader to seek legal and financial advice from legal and financial professionals.