Sole proprietorships make up about 70% of all businesses in the United States, for the simple reason that they’re exceptionally easy to start: they require minimal paperwork, offer complete autonomy when making business decisions, and enjoy low tax rates and easy tax filing. In addition, business losses can be offset by money from other income streams, like a spouse’s earnings or a second job.
But because a sole proprietorship is an unincorporated business, it comes with several disadvantages: the potential for unlimited liabilities, the inability to partner up with someone else, and the connotation of being “less professional” than an incorporated business.
Because it’s usually much trickier for sole proprietors to get a business loan, it can be hard for them to scale their businesses. Growth demands a timely infusion of capital, but with few or no assets, investors or banks are more hesitant to approve a business loan.
Sole proprietors, by the very nature of their businesses, are the face of their company. (Quite literally, in some cases, like with freelance writers or other independent contractors). Financial lenders see sole proprietors as too risky because there’s no hard separation between business and personal finances and, therefore, they can be held personally responsible for any business debts or other business liabilities.
For some sole proprietors, funding their business directly from their own savings or personal assets is the only option available. Without personal funding, there wouldn’t be a business to operate. This option also means that there’s no need to justify a business plan or convince a bank that you’re an acceptable credit risk.
Unfortunately, while self-financing can offer sole proprietors flexibility and speed, it often proves to be a stumbling block when the need for outside capital almost inevitably arises. Sole proprietorships generally find it difficult to qualify for a bank loan because they’re not seen as “credible” enough. And as a sole proprietor, your business could easily go under if you’re called out for jury duty, get severely sick, or have to deal with a pressing emergency. That’s a big risk for any lender to make.
Another popular funding mechanism available to businesses—the sale of an equity stake—is essentially closed off to sole proprietors. Investors willing to commit significant resources to a growing enterprise generally want to own a portion of the company in return for their financial investment. Sole proprietorships can’t take on new owners without losing the “sole” designation, so in the event of a new equity investment, a sole proprietorship would need to evolve into a general partnership or some form of corporation.
If you’re turned down for a conventional bank loan, there are still plenty of attractive options open to sole proprietors.
The Small Business Association (SBA) is a good resource for financing assistance with their 7(a) loan program. While the SBA doesn’t issue loans directly, they do work with lenders to fully or partially guarantee financing. If you meet certain criteria, like you operate for profit and can demonstrate a need for the loan, you have a good chance of qualifying.
There are also non-traditional lenders—like peer-to-peer lenders or microlenders—that offer small business loans with looser credit requirements. This arrangement gives borrowers quick access to capital, thanks to a shorter and more streamlined business loan application process. There is one caveat, though: interest rates tied to these loans might be higher than those attached to conventional bank loans, because of the elevated credit risk for lenders.
Private investors can also be a viable option: many organizations fund small businesses and sole proprietors when other traditional avenues have been exhausted. Business grants from federal or state governments are also available if your business and income are small enough.
Crowdfunding and crowdfund investing are other possibilities. Crowdfunding lets regular people donate to your campaign in return for a free “reward” (often the product or service you’re trying to fund) and is also a great way to get exposure for your business. Kickstarter and Indiegogo are two of the most popular crowdfunding platforms. And the JOBS Act of 2012 was put in place to support small businesses with crowdfund investing, which lets people help fund a company in return for shares of it.
A sole proprietorship has plenty of benefits, but many of the features that make this type of business entity so appealing to business owners can also work against them. That doesn’t mean, though, that outside funding isn’t an option if you’re a sole proprietor seeking to expand. By exploring all available options, including non-traditional funding sources, sole proprietors can usually secure the capital they need to take their business to the next level.