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Starting a small business can be an intimidating process. You’ve got to come up with a business strategy, solicit customers, and manage short- and long-term finances. Trudging through the paperwork, forms, and registration steps to legally set up your business can be even more frustrating. The advantages of sole proprietorships might be a great option for you, depending on how you want to set up your company. You’ll wade through less paperwork, make getting paid easier, and can focus on getting down to business.
There are numerous advantages of sole proprietorships for many entrepreneurs. They’re easy to set up, straightforward, and require fewer procedural steps than other types of business entities. One-person companies benefit specifically from the advantages of sole proprietorships—especially if their business doesn’t require a complex legal or financial setup.
But it’s important to know when the advantages of sole proprietorship are overshadowed by their limitations, particularly with regard to personal liability. This business setup isn’t for everyone; it’s best to determine if you could benefit from sole proprietorship, or if the additional paperwork for another business entity makes more sense for you.
In the big, varied world of business entities, a sole proprietorship is the most straightforward setup there is. A sole proprietorship is, as you might have guessed by the name, a company that is owned and operated by an individual. She or he is responsible for paying any debts or liabilities incurred by their business entity, and is also the point-person for any legal or tax questions that might arise.
One of the biggest advantages of sole proprietorship is its simplicity. In essence, a sole proprietorship is a permission slip for you to operate your company as an officially licensed business. This makes it easier for you to work with other vendors and clients, since you’re not technically doing work with them as an individual.
Think of sole proprietorship as the shingle you hang on the door that signals to others that you’re a company—whether or not you’re hanging that shingle in your home, an office, or neither of the two. Sole proprietorship provides you with legitimacy as an individual entrepreneur in a straightforward manner.
There’s a reason that most small businesses in the United States register as sole proprietorships: it’s easy, quick, and straightforward. Most small companies don’t need to bother with the requirements that come with other business entity types: after all, it’d feel a little silly to form a board of directors if you run a one-person hot dog stand (although you’d have great food at your annual meetings). And you wouldn’t benefit from forming a C-Corp if you’re a freelance writer, since it’d be foolish to file business taxes and personal taxes separately. Here are a few of the major advantages of sole proprietorship:
The advantages of sole proprietorship are vast and varied—especially if your company’s small. You won’t have to fill out a ton of paperwork, for starters. Other business types for small businesses, such as limited liability corporations (LLCs), require you to register with your state government before you can do business. On the other hand, sole proprietorships typically do not come with this requirement. You become a business entity merely by virtue of doing business. This allows you to scale up your business much more quickly, and with less government paperwork in the balance.
Other business entities need to file for an employer identification number with the IRS, which allows them to collect taxes and pay employees separate from the filer’s social security number. Sole proprietors, on the other hand, do not need to file for an EIN. Instead, they can use their SSN just like they would for any other financial transaction that requires it.
Another one of the tax advantages of sole proprietorship kicks in around tax time. Because you’re collecting payments through your own LLC, you don’t have to worry about filing business taxes. You’re still liable for paying taxes on any business you do through the sole proprietorship, but can take care of it through your own personal tax return. This makes filing business taxes much easier for you, since it’s as simple as submitting your own 1040.
Another one of the crucial advantages of sole proprietorship relates to registration fees. States require LLCs and other business entities to register with the state before they can conduct business. Most also require LLCs to pay a yearly fee to maintain their registration. These fees can add up quickly: most sole proprietors may not need the features and benefits of an LLC setup, so it’s not always worth paying the registration fees that come with it.
Sole proprietors don’t usually have to contend with these registration fees, since there’s no need to register with the state in the first place. So long as you don’t end up needing liability protection for your business (more on that later), you can help keep more money in your bank account.
Another clutch advantage of sole proprietorship is simplified banking. Sole proprietorships are the only kind of business entity that doesn’t require a business checking account in order to operate a company. (You can theoretically run an LLC without a business checking account, but this invalidates many of the personal finance protections that come with owning an LLC in the first place.)
As a sole proprietorship, however, you can make and accept business payments straight from your own personal bank accounts. You don’t have to go through the process of finding a business checking account, or figure out how to set up business banking in general. All you need is your own checking account to get started.
Sole proprietorships make it easy to start a business, for sure. But they also make it easier to own your business. You don’t have to concern yourself with some of the other components included in an LLC, such as a company officer or registered agent. Since you’re the sole proprietor, you call the shots. No need for boards, officers, or any of the other positions typically required by LLCs and other corporations.
This is one of the biggest advantages of sole proprietorship. You can focus on your daily operations and long-term goals without having to involve other stakeholders or deal with managing external personnel to keep your company on the right side of state and local registration.
The advantages of sole proprietorship are plentiful, but that doesn’t mean that they’re right for everyone or every business. They’re easy to set up, sure, but that convenience comes at the expense of certain protections that you’d otherwise get through an LLC or incorporated business entity. You may find that a sole proprietorship doesn’t give you the full range of protections that you need—and that the disadvantages outweigh the benefits.
Since sole proprietors don’t need to register as a business with their state of operation, they also don’t get any of the benefits that come from having a legal business entity. You’re considered self-employed with a sole proprietorship, which means that you’re on your own with regards to your business transactions.
You’re also personally liable for any of your company’s legal, financial, or tax problems. LLCs offer protections that keep creditors from being able to seize your personal assets (in most cases), and prevents people from suing you personally for business-related issues. But these protections aren’t in play with a sole proprietorship, which may open you up to additional risk.
It’s harder to secure loans for a sole proprietorship than it is for other business entities. Most banks want to work with established companies—not just because they’re typically larger in terms of revenue, but also because they tend to have a more substantial history with credit. Sole proprietors can’t usually build business credit the same way that other companies can, since they don’t have their own business credit cards and business bank accounts.
You might not be able to secure business financing from conventional lenders, but you can still seek out personal loans to help fund your business. This comes with its own pitfalls, though, since you won’t have the same level of protection as you would if your business couldn’t pay back its debts. For example, if your LLC defaulted on its loans, it’d take a lot longer for creditors to seize your personal assets. But as a sole proprietor, you’re putting up your own personal assets as collateral—and there’s no firewall there to keep the bank from taking your property.
Since a sole proprietorship is attached to an individual by nature, it’s all but impossible to sell or hand down your business to someone else. Your company lives and dies by, well, you. The business ends in the event of your death, or if you decide that you no longer want to run the company.
It’s not impossible to sell a sole proprietorship, however. But you do need to go about doing so in a different way. Mostly, you’ll have to sell your business assets, rather than the business itself. The buyer won’t be able to keep your business name, unless you’ve established a DBA and either sell or transfer the usage rights to the other party. The same goes for passing your business down to an inheritor. Make sure you work with financial and legal professionals before you seek to spin off your sole proprietorship and before making any decisions, of course.
There are plenty of advantages of a sole proprietorship for many entrepreneurs. But there are a ton of potential pitfalls as well. What you gain in terms of time and effort, you lose in terms of liability protection and credit opportunities. Be sure that your business doesn’t need these protections, both now and in the future. Otherwise you may find yourself in as tricky legal position, or playing catch-up to build your business credit history. Be sure that the perks of sole proprietorship make sense for your business goals before you make the jump.