When starting a business, a critical part of making it official is deciding how to structure it. One of the simplest structures is a sole proprietorship, coming with low startup costs and less legal documentation.
When starting a business for the first time, the easy route sounds great. There are less paperwork and fewer finances to secure. However, this business structure is not suitable for every business and comes with a few downsides that aspiring business owners should consider.
We’ll point out five pros and cons for sole proprietorships, along with a few examples of well-known sole proprietorship structures.
What is Sole Proprietorship?
A sole proprietorship is an unincorporated business that one owner. The owner, or sole proprietor, pays taxes on profits from their own pocket and cannot separate their personal income from that of their business.
A sole proprietorship is a preferred choice for startups, with low costs and little government regulation. However, all costs and responsibilities fall on the owner.
Pros and Cons of Sole Proprietorship
There are both positives and negatives when choosing a sole proprietorship. While the ease of setting up this kind of structure is attractive, the sole responsibility can make founders choose otherwise.
It’s best to consider both to make sure it’s the best choice for you and your business goals.
The Pros of Sole Proprietorship
The pros for a sole proprietorship are strong and perhaps the reason why a large majority of small businesses and startups choose them. Before we get to the drawbacks, let’s first take a look at the pros.
- It’s Easy and Cost-Effective — A sole proprietorship is a great choice for anyone looking to start a business fast. There’s no required paperwork, and you can start offering your business or service immediately. For some industries, you may need a license or permit but, that’s about as complicated as it gets. Even if you have to consider business loans, they won’t be unimaginable amounts like other business structures require.
- You’ll Get a Tax Break — With a sole proprietor-type business, you won’t have to change the way you do your personal taxes. Most businesses that have a corporate structure pay 21% on business profits, which can eat away at their long-term revenue.
That’s not the case as a sole proprietor, with owners only filing their normal personal taxes. When filing, you’ll fun into taxes like:
a. Income tax
b. Self-employment tax
c. Sales tax
- You’re Exempt from Annual Reports — Large-scale businesses with corporate or LLC structures require lots of paperwork. The federal government requires these annual filings and reports covering revenue, production, and taxes at least once every year. As a sole business owner, you won’t have to file reports or fill out more paperwork.
- Flexible Business Structure — One of the best things about a more straightforward business structure is that owners are free to make their own choices. Large organizations may have a set of rules that all employees must abide by for legal operation. That’s not the case as a sole business owner, as they can make any decisions they see fit when structuring their business.
- Keeping Track is Easy — With other business structures, companies have to keep up with a load of paperwork and documentation. From transactions to sales and everything in between, everything needs documentation. With a sole proprietorship, owners have their finances tied into the business.
This means there is no need to keep track of everything coming in and out of accounts. That doesn’t mean that owners shouldn’t keep organized. The organization is key to success, and owners can benefit from separating business and personal accounts.
The Cons of Sole Proprietorship
Though sole proprietorship is a top choice for startups and small-scale companies, it’s not absent of flaws. For example, owners have full responsibility, and if anything goes wrong, they’re held responsible. On top of that, they cannot hire contract employees, something that could get in the way of goals when it comes to growth.
- Liability — One of the biggest downfalls of a sole proprietorship is responsible. Owners are personally liable for everything from expenses to debts. There is no clear separation between an owner’s personal finances and business finances, resulting in damage to credit. If things take a turn for the worst, it will damage the sole proprietor’s personal credit and take a toll on their future endeavors.
- No Ongoing Business — In other types of business structures, a business can continue even if owners get sick or pass away. Because sole proprietorships are solely reliant on one owner, business and business services will not continue if something happens to the owner. In some cases, close friends or family members could continue business operations but, there must be paperwork filled out before the incident. Plus, owners cannot pass it down or expect operations to continue without the ability to hire employees.
- Roadblocks Raising Money — Starting a business requires money. Most of the time, entrepreneurs rely on savings, investors, and bank loans to acquire funding. However, as sole proprietors, individuals will not be able to secure certain types of funding, only funds from personal investors.
In addition, once revenue starts rolling in, owners won’t have options for equity shares. Those that choose to invest will have no say in operations or no rights to make decisions, making it riskier for them to invest. Even government help geared toward helping small businesses is out of reach for single owners, leaving them with a big bill to pay when all is said and done.
- Business Debt is Your Responsibility — On the subject of funding for startups, business loans are common to make ends meet. Business loans are beneficial for those who are first starting out, with lowered interest rates and options to make payback easier. However, sole proprietors do not qualify for business loans, taking on all of the responsibility themselves.
Sole proprietorships are not the only business structure that requires personal financing. Other structures like LLCs will need founders to secure funding on their own. But, unlike LLCs, sole proprietorships do not qualify for business loans, and all acquirement of funds falls on the individual.
- Market Perceptions — In business, it’s all about who you know. Having a good reputation and a respected form of business is key to collaborating and making a name for yourself in the market. Most businesses thrive on relationships and partnerships, using them to extend their services into other markets. Though businesses of all types are always looking for ways to collaborate, other companies will avoid sole proprietorships.
Overall, other entities view sole proprietorships as unprofessional and risky. Because there is not much financial security, other businesses and investors may avoid collaborations.
On top of that, if there is a problem, the sole owner is responsible for repairing relationships. If something goes wrong and someone says the wrong things, the small business can easily gain a tainted reputation.
A Few Well-Known Sole Proprietor Businesses
Here are some examples of sole proprietor businesses:
Amazon for Businesses
Anyone can open an Amazon business account and start selling their products. The only initial investment needed is for the product or service offered, plus a few opening costs.
Opening a business this way is cheap and simple to start and is preferred by many firtst-time small business owners.
Etsy is another widely used platform for sole proprietors. Most crafters use Etsy to display their art and sell it to those surfing the web. As a result, they score a large customer base and easily manage purchases in one platform.
Additionally, they set their prices and decide how to structure everything, giving them complete freedom.
Freelance websites like Upwork are a great example of sole proprietorships. Freelancers offer their services for a set fee and take on full responsibility for paying taxes and securing funds for initial investments.
Like Etsy, freelancers have full control over their structure, running their business however they see fit.
Understanding business structures is crucial when starting a business. There are several different options, one of which is a sole proprietorship. It’s simple and cost-effective, but individuals should beware of some of the drawbacks of a sole proprietorship. For example, the responsibilities fall only on owners, and securing funds is more complex than with other business structures.
Many first-time business owners aren’t aware of the issues that come from mixing personal and business finances. If jumping into startups too fast, founders could wind up in a bind, left to pay it all on their own.
To decide if a sole proprietorship is the best route, new business owners should take a quick look at their goals and make sure they’re making the right choice.