Advantages vs. Disadvantages: Sole Proprietorship

common knowledge that70% of businesses are sole proprietors running food trucks, designing graphics, and landscaping backyards in every state.

Entrepreneurs love sole proprietorships because of how easy they are to establish, the lack of paperwork, and the low costs.

If you’re considering starting a business, here’s what you need to know about the pros and cons of the sole proprietorship.

Advantages of a Sole Proprietorship

Firstly, let’s look at why a sole proprietorship is so popular. Note that although they’re simple to establish and come with low costs compared to other business entities, you still need additional protection to account for this entity’s weaknesses.

The best way to protect the future of your business is with a comprehensive business insurance package. Insurance defends your personal and business assets if a customer or employee sues you.

Gettinginsurance for sole proprietors is a must, as settlements can easily result in a six-figure or seven-figure payout. Thankfully, obtaining this type of protection doesn’t need to be pricey.

Less Paperwork

You don’t even need to register a sole proprietorship officially. Anyone running an unregistered business entity is automatically considered a sole proprietor for tax purposes. You'll be viewed as a general partnership if you’re running a business with more than one owner.

There are also no ongoing filing requirements for your sole proprietorship since all profits and losses pass through to your personal tax returns.

Simple Tax Setups

Your tax structure is simple enough to understand. It’s classified as a pass-through entity, so all your profits and losses are reported as personal income on your tax return. As a result, your business doesn’t need to file a separate tax return or pay any corporation tax.

You can use your Social Security Number as your tax ID unless you hire employees. It’s a standard setup as81% of small businesses have no employees. If you choose to become an employer, you’ll need to obtain a free Employer Identification Number (EIN) via the U.S. Small Business Administration (SBA).

On a side note, you may be eligible to deduct 20% of your business’s net income due to provisions set down in the Tax Cuts and Jobs Act (TCJA) of 2017.

Fewer Business Fees

Budgets are tight when you’re initially starting out. So save on registration fees by not registering at all. There are also no ongoing fees to pay because you’re unregistered.

Note that you will still need to pay for things like business licenses and permits. These costs depend on where you live and the industry you’re operating in.

Check the requirements with your local government before launching your business, as fees for non-compliance are hefty.

Simplified Banking

Sole proprietorships are the only business entity that doesn’t need a separate business bank account to operate. While this is true in theory, it’s still recommended that you open one anyway to make it easier to separate your personal and business finances.

Furthermore, opening a business bank account will enable you to accept credit card payments and written checks. You can also use it to build up your business’s credit rating, making it easier to obtain credit later.

Less Complex Business Ownership

Launching a sole proprietorship makes it easier to own your business. There’s no need for officers or registered agents, unlike if you opted for a corporation.

You are the sole business owner and have complete agency over decisions, finances, and everything else to do with your company.

There’s no requirement to hold shareholder meetings, worry about stakeholders, or negotiate with other decision-makers.

Disadvantages of a Sole Proprietorship

Sole proprietorships are not perfect by any means. However, most growing businesses will eventually evolve from a sole proprietorship to a registered business entity.

It’s essential to be aware of the disadvantages of a sole proprietorship so you can make an informed decision on the right move.

No Liability Protection

The fact you don’t need to register your business with your state also means you don’t gain any of the advantages of running a legal business entity. You’re a self-employed individual, meaning that you’re on your own regarding liability.

If you get sued, you are personally responsible for everything. Taking out business insurance can protect you from the pain, but your personal assets are as fair game as your business assets.

Attracting Investment is Difficult

Securing financing through investors and loans is trickier than with other business entities. This is because banks and other traditional lenders want to work with established companies rather than a sole proprietorship.

Although it’s not impossible to attract investment, you need to be aware of the value of a business credit score.

If you’re running a high-cost business, sole proprietorships may be unsuitable for securing third-party financing.

Selling Your Business is Problematic

The nature of a sole proprietorship is that it is attached to you by nature. You cannot sell it to someone else or pass it down to your heirs. Your business ends when you step down as the owner in every scenario.

It’s not impossible to sell a sole proprietorship, but you cannot sell your business as a whole. Instead, you would need to offload its assets individually. So naturally, this is a much more in-depth and costlier process than selling an LLC or a corporation.

Moreover, someone who buys your assets cannot keep your name because it’s attached to you as a natural person. If someone wishes to purchase your sole proprietorship, losing the name can make it instantly less attractive.

Conclusion

Starting a business means you need to give serious thought to its structure. An unregistered business entity like the sole proprietorship has its advantages because there are almost no cost burdens or paperwork.

If your goal is to start small, sole proprietorships are perfect. On the other hand, you may find that you quickly outgrow it and wish to opt for a registered legal business entity instead. It’s well worth looking into every business entity to weigh the pros and cons.

What type of business do you think best serves your venture?