What You Need to Know About Setting Up a Sole Proprietorship

There are a number of ways in which you can structure your business—from a partnership to a corporation, to a sole proprietorship, among others. Each has its own benefits and drawbacks. In this article, we'd like to examine the pros/cons of the sole proprietorship as this is among the easiest types of businesses to set up. In fact, many new/small businesses begin with this type of structure. If you are thinking about starting a business, this may be your best option initially.

Benefits of a Sole Proprietorship

With a sole proprietorship, there is no separate legal entity apart from the owner themselves. You could even use your name as that of the business if you so choose—or you can also establish a DBA (doing business as/) via your county courthouse. Your personal income represents all such income and losses for the business itself and you will have to pay self-employment tax. So what are some of the key benefits of setting up your business as a sole proprietorship…

1. You're the Boss

Meaning you pretty much have total control here. As compared to other types of businesses, there is a great deal of flexibility in terms of what you as the owner can do. For instance, the line between business and personal assets is not quite as rigid with a sole proprietorship—you can also have bank accounts in your own name for use within the context of the company.

2. Setting it Up is Easy

This is true…far more so than establishing a corporation. Depending on the nature of your endeavor, you may need to procure licensing from your state. The cost of such licensing varies—anywhere from $50-$500. And that is essentially the only real startup cost you have from an establishment standpoint. For most just starting out, this presents a very affordable way to begin their business.

3. No Corporate Taxes

Because you're a sole proprietor, you're not paying taxes on your company's profit, as a corporation would have to. The business income is direct to the owner; meaning, come tax time, you just file a personal income tax form for all of it. Keep in mind, you will still have to also file a Schedule C (profit and losses for the business/) and Schedule SE (to determine self-employment tax/).

4. There are No Annual Reports

With corporations, most are required to file annual reports and thus make public financial information. As a sole proprietor, however, you are not bound by this.

5. Record Keeping is Much Simpler

You can theoretically blur the line between your personal bank account and your business one; however, this isn't advisable. Keeping them separate in the long run is the smarter choice.

Once you hire on employees, record keeping may get a bit more confusing, as now you have to keep track of W-2s and 1099s, but it is still easier than the process involved with a corporation.

The downside to a Sole Proprietorship

While yes, a sole proprietorship is an easy and affordable way to start a new company, there are some disadvantages to be aware of.

1. Liability

Because you and the business are essentially one and the same, this makes you responsible for everything—so if the business does start to go under, you could get sued by creditors, not to mention your personal assets are at stake. You could also be liable for things such as civil damages, property damage, legal and medical damages and so forth. Basically, think of it this way: there is no legal barrier or shield between yourself and the company.

2. Continuation

As you are the owner and one responsible for basically everything, if something does happen to you, your company will probably not be able to continue on. Generally, with a sole proprietorship, there is no formal succession plan in place. If in fact, a family member were to step in, this would not be the same business; it'd be considered a brand new entity.

3. Raising Capital Can be a Problem

Because your assets are those of the company, this leaves no business assets per se. Without any such assets, it is almost impossible to get investors on board.

Also keep in mind, that investors generally like to have some say in the company. With a corporation, shareholders do in some circumstances get to have a part in the decision making process. With a sole proprietorship though, the owner is the final say—the only say in essence.

4. Business Debt Not an Option

There will come a time in the life of any company where you may need capital for some major expenditure—a new product line, commercial office space, equipment, you name it. The problem with being a sole proprietor is that you can't take out a loan in the name of the company as you are the company. Business debt is thus not an option.

The only way you could work such a loan would be to sign on as the guarantor, meaning all of your assets to include your house, for instance, would now be vulnerable should you default on the loan.

Will a Sole Proprietorship Work for You?

Hopefully, this has provided you with a better understanding of what the drawbacks and benefits are given this type of business structure. There's a lot to think about in establishing your company and you want to make sure to take the time to do it. If yours is a fairly low-risk business, for instance: house cleaner, wedding consultant, freelance graphic artist, then a sole proprietorship is most likely going to be the best way to start out. However, if yours is a higher risk endeavor, you need to carefully weigh the pros and cons of this type of business entity. If you have any questions about your business, please call today. We are here to help!