What Is a Sole Proprietorship?
A sole proprietorship—also referred to as a sole trader or a proprietorship—is an unincorporated business that has just one owner who pays personal income tax on profits earned from the business. Many sole proprietors do business under their own names because creating a separate business or trade name isn’t necessary.
A sole proprietorship is the easiest type of business to establish or take apart, due to a lack of government regulation. As such, these types of businesses are very popular among sole owners of businesses, individual self-contractors, and consultants. Most small businesses start as sole proprietorships and either stay that way or expand and transition to a limited liability entity or corporation.
Understanding a Sole Proprietorship
If you want to start a one-owner business, the simplest and fastest way is through a sole proprietorship. A sole proprietorship begins when you begin conducting business. It doesn’t require filing federal or state forms and has few regulatory burdens, making it an ideal way for self-employed people to start out.
A sole proprietorship is very different from a corporation, a limited liability company (LLC), or a limited liability partnership (LLP), in that no separate legal entity is created. As a result, the business owner of a sole proprietorship is not exempt from liabilities incurred by the entity.
Advantages of a Sole Proprietorship
Sole proprietorships have several advantages that make them popular:
- Easy and inexpensive to form. As Jeremy Shepherd discovered, sole proprietorships have few legal requirements (local licenses and permits) and are not expensive to form, making them the business organization of choice for many small companies and start-ups.
- Profits all go to the owner. The owner of a sole proprietorship obtains the start-up funds and gets all the profits earned by the business. The more efficiently the firm operates, the higher the company’s profitability.
- Direct control of the business. All business decisions are made by the sole proprietorship owner without having to consult anyone else.
- Freedom from government regulation. Sole proprietorships have more freedom than other forms of business with respect to government controls.
- No special taxation. Sole proprietorships do not pay special franchise or corporate taxes. Profits are taxed as personal income as reported on the owner’s individual tax return.
- Ease of dissolution. With no co-owners or partners, the sole proprietor can sell the business or close the doors at any time, making this form of business organization an ideal way to test a new business idea.
Disadvantages of a Sole Proprietorship
Along with the freedom to operate the business as they wish, sole proprietors face several disadvantages:
- Unlimited liability. From a legal standpoint, the sole proprietor and the companies are one and the same, making the business owner personally responsible for all debts the company incurs, even if they exceed the company’s value. The owner may need to sell other personal property—their car, home, or other investments—to satisfy claims against the business.
- Difficulty raising capital. Business assets are unprotected against claims of personal creditors, so business lenders view sole proprietorships as high risk due to the owner’s unlimited liability. Owners must often use personal funds—borrowing on credit cards, second-mortgaging their homes, or selling investments—to finance their businesses. Expansion plans can also be affected by an inability to raise additional funding.
- Limited managerial expertise. The success of a sole proprietorship rests solely with the skills and talents of the owner, who must wear many different hats and make all decisions. Owners are often not equally skilled in all areas of running a business. A graphic designer may be a wonderful artist but not know bookkeeping, how to manage production, or how to market their work.
- Trouble finding qualified employees. Sole proprietors often cannot offer the same pay, fringe benefits, and advancement as larger companies, making them less attractive to employees seeking the most favorable employment opportunities.
- Personal time commitment. Running a sole proprietorship business requires personal sacrifices and a huge time commitment, often dominating the owner’s life with 12-hour workdays and 7-day workweeks.
- Unstable business life. The life span of a sole proprietorship can be uncertain. The owner may lose interest, experience ill health, retire, or die. The business will cease to exist unless the owner makes provisions for it to continue operating or puts it up for sale.
- Losses are the owner’s responsibility. The sole proprietor is responsible for all losses, although tax laws allow these to be deducted from other personal income
Example of a Sole Proprietorship
Most small businesses start as sole proprietorships and evolve into different legal structures as time passes and the company grows.
For example, Kate Schade started her company, Kate’s Real Food, as a sole proprietor. The company creates and sells energy bars and began as a local vendor in Jackson Hole, WY. The sole proprietorship currently has a production facility in Bedford, Pa., and can be found in more than 4,000 retailers.
Since launching in 2005, Kate’s Real Food has grown to supply accounts across the country. In response, Schade restructured the business from a sole proprietorship to a corporation to take on investments and expand, a natural step for a growing business.
Created & Posted by Garima
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