Choosing the right legal structure for your business is a critical part of being a business owner. A lot of small businesses default to sole proprietorship, but it’s worth considering if that option is truly right for you. To make the right decision it’s important to know a sole proprietorship advantages and disadvantages

We will give examples of the advantages and disadvantages as well as answer some frequently asked questions.

What is a Sole Proprietorship?

A sole proprietorship is a type of company-owned and run by one person.  There is no legal distinction between the owner and the business entity.  Terms such as “sole tradership,” “sole trader,” individual entrepreneurship,” and “individual proprietorship” are used interchangeably.  

Advantages of a Sole Proprietorship

You have complete control over your business as the owner

By definition, the “sole” portion of the structure make sure that one person makes the final decision.  With other types of corporations, aspects of the business are split between different people business decisions, financial structures, legal responsibilities, and revenue splits.  For those who want complete control of the company, a sole proprietorship is the way to go.

Easier process, less requirements for business taxes

Sole proprietorships are cheap and straightforward to form.  Since the IRS views the owner and the business as a single entity, business taxes only need to be filed once.  Without involving others creating the organization is as simple as completing one person’s information.

Easier, more straightforward banking

Much like creation and taxes are simplified, so is the banking process.  In just a couple of steps, you can get started with your business account with simple instructions here.  It is always a best practice to keep person and business revenue and expenses separate, so this is a critical step to make sure you keep things properly separated.  Don’t put this off – the sooner you have your business account set up, the sooner you will have peace of mind that you are managing your business correctly.  So apply here right away.

Fewer Business Fees

The more complex a business structure is, naturally the more business fees are incurred.  Fortunately, sole proprietorships are inexpensive and straightforward.  For various types of corporations, additional fees and registrations may pop up depending on the type and location (i.e., state).  Also, corporations generally require legal representation upon inception, and of course, lawyers’ fees can add up quickly.  A sole proprietorship can be set up without any accountant or lawyer involvement (although it’s not a bad idea to have professionals answer questions if you’re unsure).

Freedom and Flexibility

Without having the constraints of more complicated business structures and partnerships, sole proprietorships flexibility to make changes dynamically and quickly.  For example, decisions like choosing to operate as an LLC or not can be made with a single person and a few simple steps. Deciding how to spend or save money can be changed quickly and easily, too.  Since the individual and the business are essentially taxed as the same entity, complicated tax rules don’t apply to business decisions that you will need to make.

The Disadvantages of a Sole Proprietorship

Personal Liability

A sole proprietorship does not inherently provide legal protection for the individual.  That means that if the sole proprietorship is pursued legally, both the business and personal assets would be at risk.  This is why many sole proprietorships also choose to operate as an LLC.  

Harder time receiving financial help and business credit

When it comes to raising funds for a business, creditors like to have strong assurances to collateralize their loans.  Whether it is a bank, venture capitalist, or even individual providing funds, they will measure the risk of financing as well as options for recourse in the event of a default.  Having multiple individuals as part of the business entity allows them to spread this responsibility across multiple sources.  Additionally, groups of people often have an excellent credit history and their skin in the game.  Lastly, a corporation – especially one with tangible assets – provides its collateral in a better way than, for example, an individual who provides consulting services or marketing work. 

Can be difficult running things on your own

Of course, the goal of any business is to succeed and grow.  Often, the small business starts as a one-person enterprise and builds to the point where there is too much work and they can no longer manage on their own.n.  After hiring employees, the business can continue to grow.  At some point, the leadership decisions, hiring and employee management, customer services issues, and financial management can become overwhelming.  If your business grows to this point, it may be time to explore partnerships and other business structures.

FAQ

What does ‘Sole proprietor” mean

A type of enterprise owned and run by one person in which there is no legal distinction between the owner and the business entity.

Can a sole proprietorship incorporate?

Yes, individual sole proprietorships can incorporate.  Please be aware that there will be additional legal and tax consequences.

Is a sole proprietorship the same as a single-member LLC?

No, sole proprietorship is a business structure while a single-member LLC is a legal structure.  Additional important information can be found here.

What are the pros and cons of sole proprietorship?

Pros include:

  • Complete Control over your Business
  • Easier Process
  • Simpler Business Taxes
  • More Straightforward Banking
  • Lower Business Frees
  • Freedom and Flexibility

Cons include:

  • Increased personal liability without having legal precautions
  • Challenges in raising capital
  • Challenges in building business credit
  • Running an organization on your own
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