Benefits of Operating as a Sole Proprietorship
Forming a sole proprietorship can be a great way for a single business owner to get a business up and running, especially if they are starting out with very little capital. A sole proprietorship is fairly unstructured so it will allow you to concentrate on building your business without the business formalities that are required to form a corporation or a limited liability company (LLC). However, while there are benefits to forming a sole proprietorship, there are some disadvantages to operating as a sole proprietorship.
Sole Proprietorship Advantages: Simplicity and Cost
One of the biggest advantages of a sole proprietorship is that it is simple to form. Many states do not even require that you register your business to start a sole proprietorship so that means that if you are already doing business, you will be automatically considered to have formed a sole proprietorship. However, it is important to remember that even if you are not required to register your business, it may be a good idea to protect your trademark rights.
Because formation is so easy, this also makes a sole proprietorship the cheapest business entity to set up. Further, there are no continuing formalities in a sole proprietorship as there are in a corporation. In a corporation, you must keep your business entity in “good standing,” which means strict accounting and lots of paperwork. There are very few formalities that go into forming a sole proprietorship, which means that you can fully concentrate on getting your business off the ground without worrying about the extra paperwork that goes into running a business using a corporate format.
Sole Proprietorship Advantages: Ease of Tax Preparation
Another advantage of a sole proprietorship is taxation. With a corporation, you must file your own income taxes separately from the business. A sole proprietorship offers “pass through" taxation, which means that the taxes on the business profits or losses pass through the business entity to the business owner. When tax time arrives, all you need to do is to calculate your net loss or profit along with your self-employment tax, report it on the Schedule SE, and attach it to your personal income tax return (Form 1040).
Sole Proprietorship Advantages: Uncomplicated Management
Additional advantages of a sole proprietorship include ease of management and lack of government control. In a sole proprietorship, you may manage your business as you see fit. A sole proprietorship is owned and controlled exclusively by you, so you face none of the hassle involved in tiered-management business entities, which often require voting on important management or financial decisions for the business. You are the owner and the final decision-maker. This can also benefit your employees because they will always know where to turn to for answers to business questions.
Sole Proprietorship Disadvantages: Liability
Perhaps the biggest disadvantage to owning a sole proprietorship is that you are personally liable for all of the debts of the business. For example, if your employee gets into a car accident while making a delivery and the injured person receives a judgment against your business, you will have to pay for this out of your personal assets if your business does not have the funds. This differs from a corporation or an LLC, where the business is treated as a separate entity and your personal accounts and home are protected from business debts. You should be especially wary of this “risky business” if you sell items that are subject to higher litigation, such as food, pharmaceuticals, and toys.
Sole Proprietorship Disadvantages: Low Attractiveness to Investors
Because a sole proprietorship is a business owned by one, you are not able to sell an interest in your business for investment purposes. Additionally, owning a sole proprietorship can appear less professional than owning an LLC or corporation. Because the formation and management is unstructured, outside investors may not take your business seriously and may hesitate to invest their money. Further, as a single-owner business, you may have fewer assets than a combined ownership. This will usually make it more difficult to raise capital or secure loans for your business needs.
Sole Proprietorship Disadvantages: One-tiered Management
While there is an advantage to being the one decision-maker in your company, this can sometimes create obstacles to productivity. Many businesses thrive on different viewpoints and ideas. Creativity can often spawn from different minds engaging collectively to solve problems. Having a business run by only one person, while easy for you, may not be beneficial in the long run. Further, while a sole proprietorship is not subject to piles of paperwork and accounting requirements, this can easily be the demise of your business if you do not maintain tight control over bookkeeping and record-keeping.
You can always change your business entity down the road as your business expands. Your business can begin as a sole proprietorship and evolve into a partnership, LLC, or corporation if you would like liability protections and investors.