All You Need To Know About Sole Proprietorships

Significant factors of the business structure set out clearly (advice from the experts).

Choosing which type of business structure will suit your business’s needs and goals requires a decent amount of research. Understanding the value that sole proprietorships can bring to entrepreneurs is important as it may be the best path for your business. 

Defining a sole proprietorship

When you talk about a sole proprietorship, the essence of this business structure is that it is operated by a sole trader (the owner). Additionally, the owner has the right to obtain the entirety of the profits made. 

  • Example: You are an excellent home baker who decides to share their love of baking with others. You offer homemade cakes to order for all ranges of occasions (and in an assortment of flavours). If you do not register your business as an LLC or corporation, the opening of your business will mean the formation of a sole proprietorship. 

Why sole proprietorships may be a good option for your business

  1. It is uncomplicated to setup and manage
  2. One person can turn a profit
  3. Filing separate taxes is not required 
  4. Paperwork and required reporting is infrequent or non-existent (allowing for more privacy and control)

Uncomplicated to setup and manage

A formal registration of your business with either the federal or state government is not required to form a sole proprietorship. Consequently, no costs are incurred (for legal requirements) to start your business. Upon beginning to sell goods and/or services you are legally considered to be a sole proprietorship. 

Paperwork and required reporting is infrequent or non-existent (permitting more privacy and control)

As no requirement for annual reports or documentation is required by law to be available for public access, paperwork and reporting is kept to a minimum. This allows for the privacy of the business to be protected. Occasionally a partnership may have to file a report, but this is rare. Additionally, being a sole trader, the owner can keep the business’s operations under their individual control

One person can turn a profit

In a sole proprietorship, only one person is needed to create a profitable business. They are operating ‘solo’. This will save the business time and money as there is no need to hire and train staff. 

  • Tip: If you find that your business requires additional employees, you can recruit help. The owner needs to obtain an Employee Identification Number (EIN) for this to be permitted. 

Filing separate taxes is not required

The owner does not need to file separate taxes for the business. You can think of these sole traders as self-employed. Therefore, the owner will be required to pay both income tax and self-employment tax. 

Why sole proprietorships may be a bad option for your business

  1. It is not considered to be an official legal entity 
  2. There is unlimited personal liability
  3. Acquiring investors, loans or credit options will be difficult

It is not a legal entity

Sole proprietorships do not form official legal entities. This is significant as this business structure will not provide you with any protection of your assets. 

Unlimited personal liability

With sole proprietorships, the owner takes on unlimited personal liability. Legally, there is no separation or distinction between your personal assets and your business. Therefore, should your business incur costly debt, legal fees or owe creditors, the owner will be responsible personally for paying these costs. 

  • If your business requires asset protection, forming an LLC or corporation will be a more suitable route. 

Difficulty getting loans, investors and credit options

It is likely that you will find getting credit lenders or investors to come on board with your business to be a hefty task. Similarly, acquiring loans will not be easy. This is because (as previously mentioned) sole proprietorships are not legal entities and therefore will be viewed as risky for investors due to the lack of asset protection.