TABLE OF CONTENTS
- Advantages of a Sole Proprietorship
- What Are the Advantages of a Sole Proprietorship?
- The Disadvantages of a Sole Proprietorship
- Drawbacks to Sole Proprietorships
- How Does a Sole Proprietorship Compare to Other Business Structures?
- Will the Advantages of a Sole Proprietorship Work for You?
Each type of business organization comes with advantages and disadvantages, and a sole proprietorship is the simplest option, requiring the least paperwork and upfront investment. One of the other benefits of being a sole proprietorship is it offers the most control over your operations.
We’ll review the advantages and disadvantages of a sole proprietorship, how it can benefit your business and how to determine if it’s the right business structure for you.
Advantages of a Sole Proprietorship
- Full control over your operations
- Simple setup and minimal costs
- No double taxation
- Some financial information can remain private
- No required formal meetings or votes
- Simple banking
- Hiring flexibility
- Non-U.S. citizens can own this type of business
What Are the Advantages of a Sole Proprietorship?
A sole proprietorship is the simplest form of business organization because it has no separate, legal existence from the owner. Your name is the business’s legal name, and you could use it as your “doing business as” name if you choose.
Let’s take a closer look at the benefits of a sole proprietorship.
What is the main advantage of a sole proprietorship? Perhaps it’s how much authority you maintain over your business. While you still have to abide by various local, state and federal laws, the amount of flexibility sole proprietors have is unparalleled in other business structures.
For example, sole proprietors can have their business bank accounts in their name. And they’re able to blend personal and business assets and funds in ways partnerships, LLCs or corporations are not legally allowed to do.
There’s no profit-sharing, so the amount of paperwork and documentation needed to set up a sole proprietorship is minimal, compared to other business structures.
The registration process includes securing permits and licenses from your state and local government to legally operate your business. Depending on the laws and regulations for each municipality, the cost for these licenses can range anywhere from $50 to $400. Sole proprietorships generally don’t have other registration requirements, so affordability is one of the advantages of choosing a sole proprietorship as a form of business.
One of the tax benefits of sole proprietorship is that your business avoids paying taxes on profit (unlike a C Corporation, for example).
Because sole proprietorships are directly connected with their owners, business income is earned by and directly passed to the owner. As a result, sole proprietorship taxes are paid as part of your personal income taxes.
Even though you are taxed through your personal tax return, sole proprietors must also file IRS forms Schedule C and Schedule SE. While both are categorized as 1040 forms—the long form for U.S. Individual Income Tax Returns—Schedule C is a record of your business’s profits and losses from the most recent fiscal year, while Schedule SE is used to determine how much you owe in self-employment taxes.
Another strength of the sole proprietorship is that it can keep certain financial information private. Other business structures, like S-Corps, C-Corps and LLCs are registered with the state and are required to file annual reports with state agencies that are often made available to the public as part of the business’s official record.
In most states, sole proprietorships are not bound by these annual filing requirements.
There are several other common business procedures that sole proprietors may forego, which further protects your privacy and control of the business.
For example, another one of the benefits of sole proprietorship is not being obligated to perform certain oversight tasks required of other business structures, such as:
Certain business organizations, such as corporations, are required to hold annual meetings and board meetings. State law doesn’t require LLCs to hold meetings, but the business’s operating agreement might mandate it. These assemblies formally review business decisions, which are then approved by managers and directors of the company, respectively.
Corporations are required to record formal minutes for annual and board meetings.
- Formal reviews and shareholder votes
In corporations, decisions on new members or managers are put through a formal review process and/or shareholder voting round before being approved.
Because there is no legal separation between an owner and a sole proprietorship, you can deposit your business revenue and pay business bills directly through your personal bank account.
Combining all of your finances can be convenient and seem like a major advantage of a sole proprietorship, but be sure to maintain clear records so you can distinguish business from personal transactions.
Your sole proprietorship can hire full-time employees (Form W-2) and independent contractors (Form 1099) after you secure an employer identification number (EIN).
As your business grows, you can hire as many employees as you need. A sole proprietorship can remain a single-person operation, but choosing to expand won’t compromise your business’s organizational structure. However, as an employer, you need to ensure you comply with safety and compensation regulations. You’ll also be responsible for all the record-keeping and tax filings that go along with managing employees.
Even if you aren’t yet a U.S. citizen, you don’t have to give up on your dream of business ownership. Non-U.S. citizens and resident aliens can own and operate a sole proprietorship, as well as several other business types — excluding S corporations.
Before you open your sole proprietorship, make sure you have the proper documents — visa or a green card, depending on your status — allowing you to work in the U.S. You should also obtain an Individual Tax Identification Number (ITIN) from the IRS; you’ll need the ITIN when filing your tax returns.
The Disadvantages of a Sole Proprietorship
While there are many advantages of sole proprietorship, there are also downsides to being legally “one” with your business.
Drawbacks to Sole Proprietorships
- Risk of personal liability
- Business ownership can’t transfer
- Challenges to raising capital
- Difficult to take on additional debt
- Not seen as a professional organization
Here are some of the risks and consequences to consider.
While one of the advantages of sole proprietorship is the full control you have over your business, you’ll also be personally responsible for every asset, liability, profit and loss your business experiences. This means your private assets are directly at stake.
Specifically, you could be held personally responsible for the following:
- Civil damages
- Property-related injury
- Product-related liability
- Business-related debts and expenses
In a sole proprietorship, any party you’ve interacted with — vendor, lender, customer, etc. — can take legal action against your business. Unlike LLCs and corporations, your assets can be seized to satisfy any obligations of the business.
Other business structures provide a legal barrier between the business and its owners. For example, LLCs or C-corps protect your assets from being seized by lenders, customers or vendors to settle business debts. Unless the business owners sign a personal guarantee that would permeate the corporate veil, this buffer protects their assets. Sole proprietors don’t get that level of insulation.
A good commercial general liability (CGL) insurance policy covering any accidents or damages can help protect you from some of these risks, but not all of them.
What happens to your business if something happens to you? If you were to pass away unexpectedly or decided to move on from the business, there would be no paperwork or succession plan with a sole proprietorship.
In other business organizations, the company would live on as long as its current leaders maintain necessary filings and licensing. In a sole proprietorship, it ends with the owner.
While an employee or family member may keep your business going, they would essentially start a brand new entity.
If you ever plan to raise money from outside investors, operating as a sole proprietorship would become impractical. Without any independent business assets, investors can’t buy into anything.
Most investors also want to have a say in the direction of the businesses they’re financing. However, every decision funnels through the sole proprietor, so there’s no voting interest for these shareholders.
Consider this scenario: Your business is growing steadily and things are going great. They’re going so great that you just received the largest purchase order in your business’s history. Only there’s a problem: You can’t afford the materials to fulfill this order.
You can apply for a loan or other financing, but operating as a sole proprietorship means you can’t secure a loan for the business as a separate entity. Lenders will scrutinize your personal credit score, debts and other financial obligations before approving your application.
If your personal financial situation doesn’t meet the lender’s standards, you might not be able to obtain financing.
Because a sole proprietorship is so closely aligned with you, your company might struggle to be seen as a serious endeavor by vendors, customers and potential partners. Paying bills through a personal checking account and using your legal business name (which is your name) can detract from any perceived professional standing.
By presenting a moniker to the public and allowing customers to pay by credit card or check directly to the name of your DBA, you can keep your business structure and continue to enjoy the advantages of a sole proprietorship with a more professional presentation.
How Does a Sole Proprietorship Compare to Other Business Structures?
Before structuring your business as a sole proprietorship, you should understand how the advantages compare to other business structures.
|C Corp||S Corp||LLC||General Partnership||Sole Proprietor|
|Limited liability on business debts and obligations for owners||✓||✓||✓|
|Company name protected by cross-state registration||✓||✓||✓|
|Business can live in perpetuity||✓||✓||✓|
|Permits unlimited number of owners||✓||✓||✓|
|Non-U.S. citizens or residents may own the business||✓||✓||✓||✓|
|May be owned by a parent company||✓||✓|
|Shares of stock can be issued||✓||✓|
|Business profit and loss can be reported on owner’s tax returns||✓||✓||✓||✓|
|Owners can split profit and loss with the business for a lower overall tax rate||✓|
|Permitted to distribute special allocations, under certain guidelines||✓||✓|
|Required to hold annual meetings or record meeting minutes||✓||✓|
Will the Advantages of a Sole Proprietorship Work for You?
Businesses without significant liability risks in their industry can function as a sole proprietorship without a big problem. For example, independent consultants, wedding planners, housekeepers, landscapers, freelance designers, computer consultants and online drop-ship retailers are excellent candidates to operate as a sole proprietorship. In contrast, businesses in the healthcare or food and hospitality industries have increased liability risks, making them poor candidates for the sole proprietorship structure.
The advantages of a sole proprietorship are great for small businesses, side projects and for when you’re just starting your business. But it has real limitations that you need to consider.
Remember that just because your business begins as a sole proprietorship, it doesn’t have to remain one. As you grow, you might want to transition to a different business structure that allows you to expand, evolve and adapt.