With a global entrepreneurship index of 83.6, the United States is the best country for aspiring entrepreneurs (at least by that metric). Currently, over 23 million sole proprietorships are operating in the United States, making it by far the most popular type of business.
Most large companies such as Amazon, Apple, or McDonald’s started as sole proprietorships before changing their legal structure as they grew. If you’re considering becoming a sole proprietor, this blog will help you understand the nitty-gritty of what it takes.
We’ll walk through the benefits and advantages of sole proprietorship and compare it to other business structures, like LLCs, corporations, and partnerships.
What Is a Sole Proprietorship
According to the U.S. Small Business Administration, a sole proprietorship “is the simplest and most common structure chosen to start a business. It is an unincorporated business owned and run by one individual with no distinction between the business and the owner. You are entitled to all profits and are responsible for all your business’s debts, losses, and liabilities.”
Whether large or small, you are automatically a sole proprietor from the moment you start a new business or work as a freelancer. But as your business grows, you’d want to team up with other people to expand your activities. In this case, you are no longer considered a sole proprietor but rather a general partnership.
Being an independent owner usually means that you are the only person running your shop or business. However, this does not prevent you from hiring employees and contracting work out to third parties. Profits from a sole proprietorship are considered the personal income of the owner.
What Are The Advantages of Being a Sole Proprietorship?
Being a sole proprietorship comes with many advantages that are not present with other business structures. Here are some of the pros of running a sole proprietorship.
1. Easy to establish and fewer requirements in terms of business taxes.
A sole proprietorship is the simplest and least expensive form of business to set up. One major advantage lies in its tax requirements. Sole proprietors are not required to file an EIN (Employer Identification Number) with the IRS like other business types.
Non-sole proprietorships must also obtain an EIN before receiving and paying employees separately from the business registrant’s social security number. As a sole proprietor, however, it’s the opposite. You can use your social security number to pay your employees and make other financial transactions outside your business. Though, it is still advisable to apply for an EIN as some advantages are associated with doing so.
2. Sole proprietorships come with fewer business fees
In the early stages of starting and running a business, your budget may be limited. So, by creating your business as a sole proprietorship, you can save on registration fees. Also, as mentioned above, states require LLCs and other business entities to register with the state before opening.
In most cases, LLCs are required to pay annual fees to maintain their registration. And these fees can quickly increase. On the other hand, sole proprietors are not subject to such fees. A sole proprietorship can save on these fees and invest them in other aspects of its business to snowball.
3. Complete ownership of your business
As a sole business owner, you have a monopoly on all decisions you make, whether financial or operational. You don’t have to attend board meetings or worry about things like officers, registered agents, or any other generally required corporate position as you would in an LLC.
This allows you to better focus on your business’s daily goals and tasks without the need to necessarily bring in other stakeholders or manage outside staff to keep your business in good standing with state and local registration.
Since you are not required to register your business officially, you preserve absolute privacy of your data (sales reports, employee salaries, etc.) and can enjoy certain freedom that you will not find in other business structures.
What Are The Disadvantages of Sole Proprietorship?
A sole proprietorship is easy to set up and comes with far fewer legal headaches. All this is good. But, these advantages come with certain constraints that you can only solve by switching from a sole proprietorship to an LLC or incorporated business entity. Here are some disadvantages of being a sole proprietorship.
1. Sole proprietorships come with an unlimited risk of liability
Since you are the sole business owner and don’t need to register as a legal entity, you are personally liable for the debts and obligations of the business. This risk also extends to any liability incurred due to the actions of employees.
For example, if your business has serious financial problems, creditors can seize your personal assets, and you can be personally prosecuted. If, on the other hand, your business is registered as an LLC, you are protected in the event of a deficit or any problems related to the operation of the business.
2. Harder to raise money or get financing
As a sole proprietor, you will have more difficulty getting loans or financing once you consider expanding your business. This is because banks prefer to work with businesses that are already established, i.e., legally registered. A sole proprietor will have a harder time getting business credit than other businesses. In addition, banks are reluctant to support a sole proprietorship due to the lack of credibility and the inability to repay debts in the event of business failure.
3. It is more difficult to sell your business
It is practically impossible to sell or transfer a sole proprietorship to someone else. As a result, your business stops working in the event of a bankruptcy or if you decide that you no longer want to run it. Even if you decide to sell the business, you will need to sell the assets of the company rather than the business itself.
How Do You Start As a Sole Proprietor Business?
Although you don’t have to create a business entity to start your sole proprietorship, there are other steps to follow for a smooth start. Here are some of the critical steps to follow:
Step 1: Evaluate your risk
Starting a sole proprietorship means exposing your personal finances to a world of responsibility. This is not a bad thing, and you have no other choice, as you’re just getting started. However, it can turn sour if you don’t first think about the risks that come with the services you want to offer.
For example, if you have a daycare and one of the children under your care gets hurt, or an unfortunate incident occurs, it is not hard to imagine that you could end up paying expensive medical bills or being sued.
Step 2: Get your employer identification number (EIN)
The EIN is a universal identifier akin to a business version of a social security number. Although you are not required to apply for this ID, it’s advisable to have it. If you do not have one, you will need to use your social security number on tax forms and other official documents. Doing so exposes your personal information unnecessarily. You can obtain the EIN for free by filling out the proper IRS online form.
Step 3: Get your business a name
Many sole proprietors usually give their business their name and a literal description of the service they offer. For example, if your name is Michelle Baxter and you decide to sell sports shoes and apparel, you can name your business Michelle Baxter Sportswear. You may not register this business name. However, if your business grows and you want to take it to the next level, you may decide to trademark your business name to avoid naming disputes later.
Step 4: Register for taxes
Although you must register for federal income taxes, you must also register for the state, county, and local taxes. And if you have employees, it’s necessary to register your business for payroll taxes.
If the goods or services you offer are taxable, the business must be registered with your state’s revenue department to collect and remit sales and use taxes. Furthermore, if you have an online business with significant sales in many states, you will need to register for sales tax in each of those states. Also, you can apply for a reseller’s certificate if you buy goods for resale. This certificate allows you to avoid paying sales tax on the purchase of goods for resale.
Step 5: Get your licenses and permits
Applying for licenses and permits is necessary before running your business. If you want to open a liquor store, for example, you must have a license that gives you the right to operate in the state, county, or municipality. This requires filling out an application, paying a fee, and submitting it to the proper authorities. There are three types of licenses to look for: premises licenses, occupational licenses, and regulated activities.
What’s The Difference Between Sole Proprietorship And Other Business Structures
A sole proprietorship is not the only form of business structure. Other forms exist that you can embrace depending on your needs and objectives.
Sole proprietorship vs. corporation
A corporation is a legal entity separate from the owners. This type of business structure provides legal protection against losses and liabilities, although it is rather procedural and time-consuming to create. Even if the owners cannot fulfill their responsibilities, corporations continue to operate, which is not the case with sole proprietorships. In terms of employee taxation, corporations have greater flexibility and adaptability.
Sole proprietorship vs. partnership
The significant difference between a sole proprietorship and a partnership is the number of owners each business structure has. In a sole proprietorship, there is only one owner. In a partnership, there are two or more. However, the two types of business structures are similar in many respects. The owners of a partnership are also responsible for everything that happens to the business. The advantage of a partnership is that the responsibilities are shared between the owners. Debts and losses are shared between partners as well as profits.
Sole proprietorship vs. LLC
LLC stands for limited liability company. An LLC is a legal entity, a limited liability company, that can be formed to own and operate a business. You can form an LLC with one or more members. Even if an LLC goes belly-up or into receivership(A receivership is a measure that allows secured creditors to recover amounts owed under a secured loan in the event that the company fails to meet its loan payment obligations.), the owners’ assets cannot be confiscated, unlike those of a sole proprietorship. LLCs are more popular because they offer the same limited liability as a corporation and are more manageable and less expensive to run.
A sole proprietorship is advisable for new entrepreneurs with limited resources. However, as the business begins to grow, it is best to switch to an LLC status to allow your business to have more flexibility, protection, and efficiency.
Examples of sole proprietorships
In general, it is recommended that you set up a sole proprietorship for relatively small activities that you can do alone or with the help of other entrepreneurs/employees. Here are some examples of sole proprietorships:
- Freelance writer
- Freelance graphic designer
- IT consultant
- Local grocery store
- Liquor store
- Smoke shop
- Local thrift store
- Convenience store
Conclusion On a Sole Proprietorship: What to Take Away?
While a sole proprietorship has its advantages, it also imposes enormous responsibilities on you to manage. Being a sole proprietor is a good thing, especially when you are just starting in business. However, if you want to see your business grow, you will need to consider moving to other business structures such as an LLC or corporation.
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