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A whopping 70% of U.S. businesses are owned and operated by sole proprietors or sole traders. But while it’s the most common business structure, many people know surprisingly little about sole proprietorship. Whether you want to learn more about sole proprietorship or are already a sole proprietor who wants to educate your friends and family, read on as we dispel five common myths about this business type.
Sole proprietorships are just as real as Apple, Coca-Cola, and Disney. Just because they’re unincorporated doesn’t mean they’re not legitimate—as mentioned earlier, they’re actually the most common type of business out there.
While sole proprietorship is the simplest business structure to form, these businesses still need to:
Yup, you read that right—your friend selling homemade cat toys on Etsy, driving for Lyft or Uber, or selling ads on their YouTube channel doesn’t get to keep all the income they earn. Although their work may seem more like a hobby than a profession, they still have to report and pay taxes on their net income, just like any other business. Plus, if they earn more than $400 per year, they may also need to pay self-employment taxes.
Alternatively, when people picture sole proprietors, they may solely think of bloggers, freelance designers, virtual assistants—basically anyone who works out of their home. And although many are indeed sole proprietors, sole proprietorship isn’t limited to just those types of businesses.
A sole proprietorship is any business where there’s no legal distinction between the owner and business entity. This can include doctors, lawyers, landscapers, franchisees, and a host of other professions. Many sole proprietors have offices, storefronts, and all of the other features you might expect an incorporated business owner to have.
The difference between the examples listed in the previous paragraph and home-based businesses is many doctors and lawyers end up incorporating when they begin hiring employees or want to protect their personal assets. Generally, these types of businesses are more likely to grow quickly (and/or be sued), so it makes sense for many of these businesses to incorporate.
Sole proprietors are just like the rest of us—they’re not necessarily content to stay where they are. Many start as a sole proprietorship since it’s often the easiest, but later incorporate as they continue to expand, hire employees, and generally grow their business.
For example, Steven Hill, owner of Simple Maui Wedding photography, decided it was time to incorporate “when we needed to start paying employees and I didn’t want it all attached to my Social Security number. I also didn’t want to be personally liable for some unforeseen mistake an employee could make, which could cost me everything I have worked so hard for.”
Many famous companies also started off as sole proprietorships—eBay started off as “Auction Web” just three years before it went public, and Kinko’s actually remained a sole proprietorship until it was sold to a private investment firm. For many companies, sole proprietorship is a stepping stone to multimillion dollar success.
Of course, while incorporating comes with its benefits, expanding beyond a sole proprietorship isn’t for everyone. Sole proprietorships come with their own advantages, and some businesses are better off staying that way forever. Which brings us to the next myth …
Sole proprietorships aren’t all side hustles that people create to earn some extra cash. While many businesses incorporate as they continue to grow, you don’t have to be a corporation to become successful. Incorporating is just one path toward growth.
For example, Michelle Huie, founder and president of compression legwear company VIM & VIGR, explains that she’s intentionally choosing to remain a sole proprietor to give her complete control and decision-making power over her business. While some may scoff at her decision to turn down “Shark Tank,” she’s proven that she’s fully capable of growing the business on her own—as of September 2017, VIM & VIGR had sold almost 25,000 pairs of socks and was on track to have a three-year growth rate of more than 250% in annual revenues.
In most articles that discuss the pros and cons of sole proprietorship, you’ll find some variation of “it’s difficult to raise capital” or “it’s hard to obtain financing” as a con. And to a certain extent, they’re right—banks might be less likely to lend to a sole proprietorship over an incorporated company.
The good news is, though, that banks aren’t your only option anymore. Increasingly, lenders are filling the gap to help make sure sole proprietorships have access to capital.
One option is to take out a personal loan, which might be easier and faster to get, as you don’t usually need to put up collateral to secure the loan, nor do you have to fill out a ton of paperwork. However, you may not be able to borrow as much as you need, and they tend to have higher interest rates than other options.
If you need a larger infusion of capital to, say, help you buy a major piece of equipment or hire more employees in preparation for the holiday rush, consider taking out a small business loan. As mentioned earlier, while your bank might not be willing to lend, alternative lending platforms are stepping in to fill the gap. For example, with Funding Circle you can get rates as low as 4.99% and amounts up to $300,000, and with OnDeck you can get rates as low as 9.99% and amounts up to $500,000. Plus, these alternative lending platforms are typically a lot faster than going through a bank, with funding in as fast as one business day versus the weeks or even months it’d usually take at a bank.
Keep in mind that if you want to apply for a business term loan, you’ll need a solid personal credit score and will likely need to submit a range of financial documents during the application process, including tax returns and bank statements.
While sole proprietorships are the most common type of business out there, it’s surprising how many misconceptions remain. Since small businesses are the backbone of the U.S. economy, and sole proprietorships make up such a large percentage of businesses today, it’s key to understand the hard work that goes into running these businesses.