A sole proprietorship is a very common and one of the simplest forms of small business structure/ownership. A sole proprietorship consists of only one owner and is not registered as a corporation, partnership, or limited liability company. With this business structure, the business can work as an independent contractor or operate a small business. Most of the home-based businesses are operated by sole proprietors and many industry-based businesses are also operate as a sole proprietorship.
What Is Sole Proprietorship?
A sole proprietorship is also known as a sole trader or a proprietorship. It is a type of unincorporated business that is run by one individual with no distinction between the business, you, and the owner. Here the business owner pays personal income tax on profits earned from the business. Moreover, in a sole proprietorship, only the owner remains responsible for all the business debts, losses, and liabilities. In this business structure, the owner and the business remain the same so the business itself is not taxed separately. There is less government regulation on sole proprietorship so it is the easiest type of business to form. Therefore, many sole proprietors do business under their own names and don’t create a separate business name to avoid paperwork.
Advantages Of A Sole Proprietorship
If you are establishing a small business then sole proprietorship would be the best business structure for you. This is because forming a sole proprietorship requires less paperwork and has low set-up costs. Moreover, it is very easy to manage this business setup. Here are some key advantages of sole proprietorship –
A sole proprietorship doesn’t require separate taxes for the business owner and business. Any profit the business owner makes is simply treated as the owner’s own income. So, the business owner only has to file personal income tax. However, you should consider two very important tax details to consider as a sole proprietorship:
1. You will be taxed for all the profits of your business, whether you withdraw the money or not
2. You have to fill out a Schedule C report, which details your profits and losses, along with a Schedule SE, which refers to your self-employment taxes
You have to submit both files with your personal 1040 income tax return at tax time
Compared to other business structures, a sole proprietorship is easier to start and maintain. A sole proprietorship doesn’t have any state requirements and it requires minimal legal cost. So, you can simply establish the business and run the business. Moreover, you can also use a fictitious name known as a DBA (doing business as). Another advantage of a sole proprietorship is, you don’t need to obtain an employer identification number (EIN) from the IRS which is very convenient.
In a sole proprietorship, the business owner has complete control and decision-making power over the business. There is no business partner in sole proprietorship so, you are the sole owner of the business and can therefore run it as you want.
Disadvantages Of A Sole Proprietorship
A sole proprietorship has some disadvantages too. Therefore, before forming a sole proprietorship you should know the cons of this business setup. Some key disadvantages of a sole proprietorship are –
3. Long-Term Survival
4. Lack of Support
Liability is the biggest concern of sole proprietorship business structure because in this structure the owner is left liable for all obligations of the business. The obligation includes debt and lawsuits. In this business structure, there is no separation between business assets and personal assets. So, if the business fails then it might fall the personal assets in danger.
Fundraising is a big challenge for sole proprietorship businesses because it is not possible for this type of business structure to sell stocks in the stock market. Therefore, investors would hesitate to invest in the Sole proprietorship business. Moreover, it is also difficult to take loans from banks because if the business fails then all the responsibilities fall on the shoulders of the owner!
3. Long-Term Survival
This is another disadvantage of sole proprietorship because this type of business rarely survives if the owner dies or is incapacitated. A corporation is a separate entity from its owners therefore the owner can be taken over by someone else. On the other hand, a sole proprietorship must be run by its owner.
4. Lack Of Support
Sole proprietorship lacks support from others. Here the owner alone is responsible for the successes and failures of the business. So, it can add extra pressure and stress to the owner and the owner might not be able to concentrate on the business development.
How To Start A Sole Proprietorship?
Starting a sole proprietorship is very easy. If you are wondering how to start a sole proprietorship then check the below steps –
1. Choose a business name
2. Register your business name
3. Purchase a domain name
4. Obtain a business license and other permits
5. File for an employer identification number (EIN)
6. Open a business bank account
7. Get insurance coverage
1. Choose A Business Name
The very first step of forming a sole proprietorship is to choose a business name. Try to pick a business name that is unique and succinctly describes your business. For sole proprietorship, you can also have your business name be the same as your personal name. if you select a business name then check the United States Patent and Trademark Office (USPTO) to see if they’re available. Once you find an available business name you like, you can move to the next step.
2. Register Your Business Name
As a sole proprietor, the legal name of your business is usually your own name but if you want then you can operate under a different name, also known as a DBA. In order to register your business, you have to publish the name, you’ll be doing business under publicly and then provide proof of publication to your local government and register the business name.
3. Purchase A Domain Name
Once you have picked your business name, the next step is to buy a domain name similar to your business name. You should try to set your domain name as the same name as your business to avoid any confusion. If the domain name is not available then try to come up with a variation that is still similar to your business name.
4. Obtain A Business License And Other Permits
Every sole proprietorship business needs to register for a business license to operate. Depending on the business you should obtain all the appropriate business licenses and permits. Without the appropriate licenses or permits, you can’t operate your business properly. What type of license you need depends on the business type as well as which state and local area you’re operating in. For example, if you want to open a daycare then you will need a health and safety training license. Similarly, you will need a health department permit if you want to prepare or serve food. Other types of licenses are –
1. A federal license for transporting animals
2. A certification exam to become a financial advisor
3. A zoning permit to operate your business from home
5. File For An Employer Identification Number (EIN)
If you run the business by yourself then you won’t need an employee EIN and can operate and file taxes under your social security number. However, if you hire employees then you’ll need an employer identification number (EIN). You have to provide the EIN to the Internal Revenue Service (IRS) when you file the taxes. Obtaining the EIN is very easy and it won’t cost you any money.
6. Open A Business Bank Account
Though in a sole proprietorship the personal asset and the business asset are the same you should try to separate your business expenses from your personal expenses. So, if you can open a separate bank account for your business then it will allow you to accept credit card payments and written checks. Moreover, you will be able to build a credit history for your business.
7. Get Insurance Coverage
You must get insurance coverage for your sole proprietorship business because this type of business structure has unlimited liability for the business owner. So, having additional insurance coverage can limit the risks and give your assets more protection. Depending on the business you can look into the following types of insurance:
1. Property insurance
2. Liability insurance
3. Auto insurance
4. Health insurance
5. Disability insurance
Sole Proprietorship Business Examples
Some common examples of sole proprietorship business are –
Bookkeeping Business: This is a common example of a sole proprietorship business where accounting, bookkeeping, and tax preparation services are provided to businesses of various sizes.
Home Healthcare: The healthcare industry usually remains stable both in a good and bad economy. Therefore, many sole proprietors try to gain profit from home healthcare businesses. Home healthcare service includes cooking meals, cleaning homes, etc.
Financial Planner: Many financial planners start a sole proprietorship and offer various services that include planning services to individuals and small businesses. A financial planner provides retirement plans, saves for college expenses, and invests in securities.
Landscaping Company: Usually landscapers maintain lawns, plants, and trees of homeowners and businesses. So, if you run a small landscaping business, then a sole proprietorship would be a good fit.
Computer Repair Services: Most computer repair service operates as sole proprietorship and provide various service like hardware repair, software installation, etc.
Catering Company: Catering companies offer various services like organizing parties, weddings, church functions, and business events. In most cases, a catering company is a sole proprietor.
Housecleaning Services: Here, business owners provide laundry, window washing, carpet cleaning, etc. Opening a house cleaning service is very easy and it won’t require much investment.
Freelance Writer: Many freelance writers operate as a sole proprietor and provide content to businesses owners or writes content to sell to consumers.
Tutoring Services: Tutoring businesses offers learning assistance to students in a variety of subjects. Tutors provide teaching in person as well as through online video chats.
Finally, a sole proprietorship is the basic business structure for an individual to start a business. This business structure doesn’t require registering with a state authority as well as doesn’t require creating an EIN with the IRS. However, before opening a sole proprietorship you should be aware of the risks involved with this business setup.
Magalie D. is a Diploma holder in Public Administration & Management from McGill University of Canada. She shares management tips here in MGTBlog when she has nothing to do and gets some free time after working in a multinational company at Toronto.