6 Lousy Disadvantages of Sole Proprietroships


The Cons of Sole Proprietorships:

  • You are personally liable for the business’s actions

  • Limited options reduces functionality

  • Unable to open a business bank account 

  • It’s a simple business making it less official

  • Unappealing to potential investors

  • Sole Proprietorships are difficult to sell

Sole Proprietorships are business entities owned and managed by a single person.

You!

You get all the profits. 

The downside is the personal responsibility of staying on top of business debts and legal issues should they arise. 

If you don’t take care of them, lawyers and banks can take your real estate, savings, investments, vehicles, and any other property or assets you own to pay for what the business owes. 

If you had an LLC or Corporation, you would get personal liability protection from business debts or legal battles. 

These protections only 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. 

A lot of entrepreneurs start out with a Sole Proprietorship. Then, as the business grows, they re-form them into LLCs, Partnerships, or Corporations. 

➤ MORE: Learn the in's and out's of LLCs.

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 the state you’re operating in. 

Dissolving your Sole Proprietorship is easy because as soon as you stop operating, the business ceases to exist. This can be through selling your business, closing the business, or the death of the Sole Proprietor.

Check us out on Twitter:

Liability

Sole Proprietorships aren’t stand-alone legal entities, separate from the owner. 

As the “sole” owner, YOU are the business. 

The biggest downside of running your business as a Sole Proprietorship is the complete lack of any sort of personal protection. You are personally responsible for business debts, legal problems, taxes, and decisions. 

This inherent risk applies to every aspect of your business. If what you’re doing is already risky, this can cause serious problems.

If your business can’t pay back creditors or catches a lawsuit, it means you personally owe money or you’re personally getting sued. Banks and lawyers can then gain access to your personal belongings as a form of payment. This includes personal bank accounts, real estate, vehicles, investments, and other assets.

As a sole proprietor, you don’t receive the legal protections associated with state-registered businesses, like LLCs and Corporations, since you don’t register with the state. 

For these reasons, it may be a good idea to get special insurance for your Sole Proprietorship to cover injuries or physical losses which have led many businesses to ruin. Before you make any binding financial decisions, you should speak with a CPA, a Certified Public Accountant. 

Reduced Functionality

Let’s say you want more people to join and share ownership of the business, you can’t keep it a Sole Proprietorship. The only way two people can run the same Sole Proprietorship is if they are married. This is what’s known as a Co-Sole Proprietorship. 

If you want other owners or shareholders to get involved, you have to dissolve the Sole Proprietorship and reform it as a Partnership, LLC, or Corporation, depending on your unique needs. 

In the event of the owner’s death, all the company’s assets, profits, and property go to the owner’s family or whoever is in their will. This direct transfer is subject to Inheritance Tax, dramatically reducing the amount your inheritors receive.  

This is a negative aspect because someone else can’t just come along and pick up where you left off. In an LLC or Corporation, the entire entity can be transferred, exempting it from Inheritance Tax. 

No Business Bank Account

Most banks don’t allow you to open up a business bank account for a Sole Proprietorship on its own. The few that do require a DBA (Doing Business As…) name and/or an EIN (Employer Identification Number). 

This is a negative of Sole Proprietorships because you’re missing out on getting in the habit of distinguishing between business and personal finances. A practice which comes in handy if you plan on expanding to an LLC or Corporation, where separating business and personal is mandatory. 

➤ MORE: We breakdown the Pros and Cons of Sole Proprietorships and LLCs.

Lacking Credibility and Rapport

As a sole proprietor, you must operate under your full legal name. Not only do you miss out on amazing advertising opportunities, it also makes building confidence in your product or service challenging. 

To illustrate, imagine a lawn care service owned by Joe Robinson. 

Someone speaking about his services would probably say, “Oh yeah, there’s Joe Robinson who cuts lawns and also does some nice landscaping… Yeah, I think he lives just across town… Sure, I can send you his number. *Sends the contact titled: Joe Robinson*” 

There’s just nothing professional about using your legal name for your business. 

If you end up operating a Sole Proprietorship, you should complete the extra step of filing for a DBA (Doing Business As…) name. This is a custom, industry-specific, name of your choosing. 

If Joe had a DBA, someone would refer to his services as such: “Oh yeah, Joe’s Lawn and Landscaping is great! Here, scan this QR code to check out his website for pricing and contact information.” 

The added professionalism is reason enough to get a DBA for your Sole Proprietorship. 

Difficult to Get Funding

The only “requirement” to starting a Sole Proprietorship is running a profitable, organized business. Unfortunately, this means regardless of if you reach out to, whether it’s private investors or banks, they’re going to be hesitant to fund a sole proprietor. 

How you acquire funding depends on your investments, credit history, financial background, and your network. Unless you can cover the initial investment yourself, you will either have to rely on crowdfunding, a generous relative, or a friend who’s got your back. 

Acquiring a loan is harder if you are lacking or have bad credit. Banks prefer working with established companies who have been in the “business” of being a business and have a strong credit history. 

If you’re just starting out, personal loans are also risky because you’re putting your personal assets on the line. If things turn sour and the bank wants their money back, but you’re unable to pay, they will come after your personal property. 

You can not build business credit as a sole proprietor because Disregarded Entities are unable to set up business credit cards and bank accounts. You do have the option of filing for a DBA and registering an EIN with the Internal Revenue Service. Depending on the state and the bank, this could allow you to open a business checking account. 

You also can’t sell an equity stake in exchange for obtaining new funds. To rephrase it a little differently, you can’t offer stock or other investment incentives like you could with an LLC or Corporation. 

Difficult to Sell

Sole Proprietorships are great if you seek total control over your business, but selling one is no simple task. It is nearly impossible 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 just can’t sell the business as an entity since, technically speaking, you are the entity.

Additionally, you can’t sell or transfer the business name, unless you have a registered DBA (“doing business as” name). Without a DBA, your business name is simply your legal name.

All of this is to say, you can sell or transfer a Sole Proprietorship if you really want to. It is much more complex than selling or transferring an LLC or Corporation, which is officially registered and recognized by the state.

➤ MORE: Find out how LLCs compare to Sole Proprietorships.

Is a Sole Proprietroship Right for You?

Some businesses are more complicated and offer protections and special taxation. Other businesses, like Sole Proprietorships, are seemingly effortless but don’t offer any special features. 

No matter what type of business you decide on, you will find benefits and drawbacks. It is important to find the business with the right balance for you and your needs. 

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 binding decisions regarding starting, operating, and growing your business. Use external resources independently of “Business Initiative.” It is the responsibility of every reader to seek legal and financial advice from legal and financial professionals.