Perhaps the simplest form of a business entity, a sole proprietorship is a company owned by a single individual and it is one that remains unincorporated. As far as getting started in the business, this is the route that many startups will take until they reach the point of growth that calls for them to restructure. There are millions of sole proprietorships throughout the country. As far as taxes go, a sole proprietor will run the business through their returns, simplifying that process as well. In this article, we look more in-depth at what a sole proprietorship is and what some of the benefits and downsides of establishing one could potentially be.
Understanding Sole Proprietorships
Unlike a corporation, a sole proprietorship offers no legal separation between the individual and the business. This means that the owner of the company is responsible for any debts and liabilities that the company may incur. And if there is any legal action involved, it would come back directly on the sole proprietor. That said, there are several key benefits to setting up your company within the context of a sole proprietorship.
A few of the benefits of establishing a sole proprietorship include:
- It is very easy to start and it is also the least expensive type of business entity to launch. You don't even need to register an official business name as a sole proprietor.
- Numerous startups and self-employed freelancers will start as sole proprietors, again because of the ease and cost-effectiveness.
- You maintain full ownership of your company.
- The tax process is greatly streamlined as is the overall accounting process.
Sole proprietors unlike corporations, do not have to have shareholder meetings. The sole proprietor is the full owner of the company, meaning they have total control and do not have to defer to partners or shareholders. There is no voting on issues as they make all of the decisions for the business. This makes for a far more flexible schedule in terms of how you work, when and where you work, and how many hours you opt to work. Largely, the terms and conditions of your work will be based upon your clients' needs and deadlines.
Taxes again are made much simpler within the context of a sole proprietorship. There is no separate tax return for the business, rather personal and business taxes are filed as one. This is because the owner of the company receives all revenue generated as income. And as with most other types of business entities, relevant expenses can be deducted from that income to include such things as travel costs, marketing/advertising expenses, if it is a home-based business a percentage of home costs can also be deducted, car expenses, as well as office supplies—and these are just a few of the things that you may be able to deduct as a sole proprietor. Being able to deduct expenses can be incredibly beneficial especially in the early phases of a business, as losing money can be more common. You can therefore deduct losses/expenses from personal income and thereby pay less as far as income tax.
Some of the disadvantages associated with sole proprietorships:
As a sole proprietor, you own and operate your own business. Generally, this means you do so alone. Therefore, you have no partners with whom to collaborate and/ or bounce ideas off of. When trying to explore new avenues for the company, this could put you at a disadvantage. Among some of the other cons associated with being a sole proprietor…
- There is no legal separation between business and personal; this means you are on the hook should any legal issues arise.
- You are responsible for all of the company's debts and liabilities.
- Your business income gets reported as personal income.
- It could be harder to get contracts when you're up against a larger company or corporation.
- The company is not as attractive to potential investors and/or those who are looking to purchase a company.
Because as a sole proprietor you are responsible for all business debts and liabilities, this puts your assets at risk. Meaning, if a creditor is trying to collect on a debt owed, they could theoretically go after your home, stocks, retirement accounts even. Any relevant personal assets can be seized to this end.
Granted, in this type of business structure the tax process is simplified, however, this also means that all business income has to be reported as personal income for that tax year. With a corporation, there is greater flexibility as far as how owners are paid which could also help as far as taxes go.
There is also the disadvantage that some contracts will be out of your reach as a sole proprietor. That is to say, there are some businesses and government agencies especially that will not allow sole proprietors to bid on contracts. This could be because they recognize corporations as having more legitimacy. Or it could be because of tax purposes. So keep that in mind, particularly if you intend to go after government contracts at some point.
As far as eventually trying to sell the business, if you are a sole proprietor this can be a more difficult feat. Plus, as you are the one running the business, you are essentially its greatest asset; this may turn off potential buyers. Your customers are loyal to you as the owner and therefore that loyalty is likely to waiver if you're no longer connected to the company.
First Union Lending has been working with small business owners to include sole proprietors for years now. We are invested in helping our clients thrive and succeed. With short term loans, lines of credit, and merchant cash advances, among other products, we have a financing solution to accommodate your working capital needs. Some clients receive the cash in their accounts within two business days—we do work that quickly. Call today and let's get started together!