A sole proprietorship is a business which is owned and operated by a single individual or a married couple in some jurisdictions. There isn’t a legal distinction under this structure between the business and the owner. They are one and the same, which means all business profits and losses are reported on that person’s (or couple’s) individual tax return.
This business structure is the most popular form used today because it is easy to setup and use. In many U.S. states, you can begin conducting business immediately without the need for licensing, skill verification, or commercial assets. The only requirement is to register the name of the business, secure local licenses which may apply, and you’re ready to start making money.
If you operate a digital business as a sole proprietor, you may be able to avoid most licenses too.
Because there are various risks and rewards that are possible under this type of business structure, it is essential that anyone thinking about working for themselves review the pros and cons of a sole proprietorship first.
List of the Pros of a Sole Proprietorship
1. Most sole proprietorships require few legal formalities.
When you start this type of business, you’re not required to create a business name for yourself if you conduct business using your name only. That means you can setup shop on the Internet to sell goods or services immediately. Because there isn’t a formal business organization created, your administrative responsibilities are minimal. Most people need to file with their local office to start working. If you’re thinking about being an independent contractor or freelancer, you might not even need to do that.
2. Startup costs for a sole proprietorship are small.
This business structure is the cheapest and easiest to get started. Although you’re not entirely free from costs, there are fewer legal fees which must be paid to get your idea off the ground. The requirement for licenses and permits is usually minimal, if they exist at all. That makes it easy to start small, test out an idea, and then expand when the time as right. Numerous businesses that are successful today got their start using this type of business structure.
3. You can upgrade your business structure at any time.
You’re not required to stay a sole proprietor forever when you start this type of business. If your concept is doing well, then you can take the next step to expand your business operations by incorporating. The process of shifting to a limited liability corporation or an S-corp is straightforward in most jurisdictions. You can also shift to a general partnership if you want to bring someone else into the opportunity.
4. There is more management flexibility with a sole proprietorship.
If you want to become your own boss, this business structure will make that happen for you without much trouble. You have complete power over the decisions you make for your business. That’s because you are the only one who is running the business. There isn’t a need to get approval from a board of directors or consent from partners to move forward on an idea. That means you can save time, energy, and money when it is time to take your company in a new direction.
5. You have sole discretion over costs and spending.
When you’re in charge of a sole proprietorship, then you are the one who is responsible for the buying, spending, and selling that occurs. You’re the one who holds all the strings, which means it is up to you to ensure asset allocation is performed correctly. Owners of a business using this structure are not subjected to the same scrutiny of shareholders, partners, or board members as they would be in a different structure.
6. The profits generated by the company are all yours.
Because you are the sole owner of the company, as a sole proprietor, all of the profits become your personal income. You’re not required to split the income with anyone. That means you can make back your initial investments faster, offer quicker responses to customers or employees, and keep moving forward whenever something strikes your fancy.
7. You can hire employees.
If you are sole proprietorship, you can still hire employees. You’ll be required to meet salary, tax withholding, and safety standards in your community to do so. In the United States, you’ll be required to have an employee identification number as well, whereas if you just work on your own, your Social Security number will suffice.
8. Spouses can own a sole proprietorship together sometimes.
Although this structure was originally called a “husband/wife” sole proprietorship, it now applies to any couple which is legally married. Under this structure, a spouse is permitted to work in the business without being classified as an employee. Since the spouse is not a partner or independent contractor, they’re not responsible for self-employment taxes for the work being done. It is a structure that is informal, however, so if both parties make decisions together, a partnership is a better structure to use. That way, if something happens to both of you, the business agreement will give you some continuity.
9. Your accounting work takes less time under a sole proprietorship.
When you operate a sole proprietorship, especially a small one, then you only need one set of books for taxation purposes in most jurisdictions. As long as you’re keeping track of incoming revenues and outgoing expenses, you’ll be able to file taxes because the profits are treated as personal income. You don’t need to keep separate books for different partners, the legal structure of an incorporated business, or tax books. Most sole proprietors can do the accounting on their own.
10. You don’t need to hold mandatory meetings.
When your company is incorporated, you must hold mandatory meetings with the board of directors, other partners, and anyone else mentioned in the articles of the business. You must take notes of these meetings and make them available to the public or send them to the state when you renew your authorization each year. You must also present formal financial documents that can be time consuming in other business structures that aren’t a requirement when you’re operating as a sole proprietor.
11. You will find it easier to dissolve a sole proprietorship than other business structure.
If you are operating as a sole proprietorship, then you can cease all business operations whenever you want to stop. You’re not forced to go through the process of closing out responsibilities created by your formal registrations. Just pay off any business debts you have, conclude your obligations, and then close out your accounts. You must notify the tax authorities about your decision and file one last annual return with your income, but that is the extent of your responsibilities under most circumstances.
12. You can take business losses to offset personal income.
If your business doesn’t make money when operating as a sole proprietorship, then in the U.S., your Schedule C gives you the ability to report it as such. That loss will then offset your other sources of personal income to reduce your overall taxation responsibility. Although keeping business and personal taxes separate is beneficial too sometimes, you can use business expenses, such as rent, utilities, purchases (with receipt evidence), to reduce your overall income to limit tax responsibilities as well.
13. You get to set your own hours (kind of).
When you operate a sole proprietorship, then you make the decisions as to when (or if) you want to work. If there’s a vacation you want to take, then you can close down the business until you return. You can take a day off whenever you want. Of course, that also means you might lose income opportunities for that day as well. If you’re the only one working within the context of your business, there are no paid sick days or holidays. You must incorporate the value of this off-time into your profit structure to reduce lost days of income.
14. You have no hoops to jump through when paying yourself.
When payday comes along, then you get to pay yourself from the profits your business earned. You’re not required to setup payroll to pay yourself. That means you’ll be required to pay estimated taxes in the United States instead, which are quarterly payments based off the income you reported in the previous year. Then you file your taxes, pay any tax remainder, and you’re set for the year.
List of the Cons of a Sole Proprietorship
1. You face unlimited personal liability if something goes wrong.
The primary disadvantage of being a sole proprietor is that you are personally responsible for the business. There is no separation between your personal or business assets. If your company suffers losses, then you shoulder all the liabilities. Corporations might cost more to setup initially, but that structure provides personal asset protections that a sole proprietor does not receive. All obligations and debts incurred by the business are treated as personal obligations and debts.
2. Business creditors can go after personal assets if you’re a sole proprietor.
If you run a business under the sole proprietorship structure, then your creditors are permitted to pursue your personal assets to make themselves whole. Nothing is off-limits for them. If you’re unable to pay your debts, then your house, your care, and other real properties are fair game. Your creditors can even pursue your personal savings and checking accounts, even if you keep separate books. A sole proprietor is always at-risk of losing everything if their business is not successful.
3. Your business does not exist outside of you.
When you operate as a sole proprietor, you gain all the advantages of being personally in charge of every decision. If something unfortunate should happen to you, however, then your business is forced to close. You’re not permitted to resign from the company. When you stop working or pass away, then your business will cease to exist. There is no continuity, which means you can’t even pass on your opportunity to your children unless you have a spouse which jointly owns and operates the business with you.
4. You will find it virtually impossible to raise capital.
If you decide to form a sole proprietorship, then the money needed to begin building the business will come from your own pocket 99.99% of the time. Banks and other lending institutions are extremely hesitant to offer capital to businesses using this structure. Investors don’t get involved either because there is no equity available to them. Even if you can establish that your business is stable and profitable, there are fewer lending opportunities available to you compared to other business structures.
5. You bear the burden of making every decision.
When you operate as a sole proprietor, the benefits of being the sole decision-maker are also a disadvantage. Even if you have consultants and managers helping you with the daily operations of the business, the final decision on everything rests in your hands. You can defer to others for their advice, but it is up to you to initiate what the business does in everything. That means you are solely responsible for the success or failure of your business and its employees, which could be a difficult perspective for some people to handle.
6. You are working in a structure that is considered to be informal.
Because a sole proprietorship is not a legal entity, the business world doesn’t always see it as a formal company. That means your opportunities may appear to be less professional than something similar offered by a partnership or corporation. Although you get to choose the course your business navigates, the competition may have an extra advantage over you simply because they invested more time in the formation of their company.
7. You’re going to be working longer, harder hours as a sole proprietor.
Most sole proprietors work on their own. They do all the work, make the decisions, and provide outcomes for their customers. Instead of working a 40-hour week like a traditional employee, these owners are working 50- to 60-hour weeks instead. Sole proprietors might not get some holidays off like other workers. It can be difficult to schedule vacations. Even taking a sick day might mean you lose money. Many sole proprietors discover it is easy to get burned out with this schedule if they don’t have the discipline to take time off when it is needed.
8. You will be signing contracts in your own name instead of the business name.
When you operate as a sole proprietor, your business and personal identity remain one. That means any contract you sign for the business will be a personal contract. Matters of public record will publish your name and address, so if you work from home, people can look up where you live. That also means you are the one who is liable if your company is sued for some reason because the judgment will be in your name, not your DBA.
9. Your credit is based on your personal profile, not your business profile.
If you are able to receive lending products for your sole proprietorship, it is because your personal credit score is high enough to warrant the offer. Your business doesn’t have a separate legal identity, which means you’re not privy to the business interest rates or capital that is available. Your business credit cards and loans are your personal credit products. Some sole proprietors receive a “business debit” or similar product to use with their account, but that is the limit of separation most owners can achieve.
10. You must pay your taxes as you go.
The tax structure in the United States requires workers to pay income taxes on their earnings when the money becomes available. For the sole proprietor, that means there is a requirement to pay estimated taxes each quarter on their income. Many first-time owners don’t realize this requirement, only to discover an unpleasant surprise waiting for them at the end of the tax year. If you underpay your tax obligations by $1,000 or more, there is a penalty levied on the amount you owe for the year. Because tax rules and obligations change throughout the year, you must always know what your responsibilities are. If you earn more income than expected, your quarterly tax payment will be higher at the federal level.
11. You will be filing taxes more often.
If you are a traditional employee, then you file taxes once per year with your W-2 income statement. For sole proprietors, their state and local taxes may require quarterly or semi-annual filings which involve sales tax collection, business and occupation taxes, or similar responsibilities. Large sole proprietorships may be asked to file taxes once per month if their income levels are high. Although other forms of paperwork are minimized with this business structure, you’ll be doing more administrative tasks compared to workers who are employed.
The pros and cons of a sole proprietorship eventually come down to the amount of risk you’re willing to assume. If you don’t mind being personally responsible for business debts and obligations, then it is a structure which you may find to be beneficial. When there are personal assets at stake which you don’t want to lose, then an incorporated business structure is a better idea, such as a one-person LLC.