Advantages and Disadvantages of Sole Proprietorship - Is It Worth It?

11

Min Read

Tom Smery

If you are planning to set sail on your own, you might be wondering what the advantages and disadvantages of sole proprietorship are. It is worth setting up your own business structure, without bringing any other partners in the mix?

Sole proprietorships have their hiccups, but they also come with a few advantages. Read on to find out the advantages of a sole proprietorship, along with its drawbacks, to see whether it's up your alley or not.

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What Is Sole Proprietorship?

When someone is a sole proprietor, it means that they are linked as the only owner of the business. Among business structures, this one is the simplest type there is, as there is no need for federal registration.

Sole proprietors can be owners of a startup, freelancers, people with workshops or physical storefronts, creatives, and so on. A sole proprietor can hire as many people as they want, but they'll be the ones liable for paying wages, their taxes, or their benefits.

What Are the Advantages of Sole Proprietorship

Being a sole proprietor has its advantages, which makes it a suitable option for those wanting to start up such a business structure. Here is why sole proprietorships are so convenient:

They Are Very Easy to Establish

A sole proprietorship is very easy to establish, as you don't have to formally register your business entity, nor do you have to notify the state or federal offices. All you have to do is register the business fee, but without the formal roundabouts of an LLC, and then obtain the licenses and permits necessary.

This advantage makes it quite easy for you to create a startup that you are only using as a side gig. This allows you to only be partially committed to the business, without sacrificing any attention you'd have to give to your day job.

Not As Much Paperwork

If there is anything that business owners know best, it's that paperwork can be a total pain. For example, the disadvantages of an LLC or a corporation is you will have to file documents every year. You'll have forms to handle, taxes to pay, and headaches to get over.

With a sole proprietorship, this is not the case. Filing these documents every year is not mandatory, and with other types of paperwork, the process is also simplified. One of the biggest advantages of a sole proprietorship is that you do not even have to pay a bookkeeper to make matters easy for you.

You Can Hire As Many People As You Want

You may be a sole proprietor, but this does not mean that you will have to be alone. When considering the advantages and disadvantages of a sole proprietorship, most people give up simply because they believe they need to be the sole worker of the business.

This is by no means true. As a sole proprietor, you may hire just as many people as you want. As long as you can afford to cover their expenses, legally speaking, you are entitled to grow your reach and your business - all without formally turning into an LLC or incorporating the small business.

At first, there is a very good chance you will be by yourself with this type of business. However, when your sole proprietorship starts bringing a profit, you may hire as many people as you want. This should allow you to take a leap and grow your profits even more.

You Can Trademark the Sole Proprietorship Name

When going for a sole proprietorship, your name very often becomes your business name. However, there is also the option of operating under a specific business name. All you have to do is to register your trademark in the U.S. Patent and Trademark Office.

You might want to check the search system first, to ensure there is no one else registered under the name that you want. They will be the ones having proprietorship of the name - so, choose something that no one else has. This way, you'll be more easily recognized.

The whole process won't take more than 90 minutes to get exclusivity to the name as a business owner. You won't even need a lawyer for this. Once it is done, you'll be able to differentiate yourself from your competition.  

You Get Complete Control Over the Small Business

A sole proprietorship is tied to your legal name - so, you have complete control over your form of business and what its trajectory should be. You don't have any shareholders messing with your head and telling you what you should do, and you do not have any legal partners putting up conditions.

This freedom to make your own choices for the business also gives you the flexibility to experiment. If you have a crazy idea that you think may bring a lot of profit, you don't have to go past any other uncertain shareholders to test things out. You are free to do exactly what you want.

You have limited liability for the company that you are running. You aren't restricted to any strict or complicated regulations. Sole proprietors have the freedom to make any decision that they see fit.

It's a Stepping Stone for LLCs and Corporations

When it comes to sole proprietorships compared to LLCs, think of it as a stepping stone for corporations in general. Take eBay, for example. Before Pierre Omidyar started eBay, he ran a platform called Auction We, where he was a sole proprietor. Only later did he incorporate the business under eBay, at which point he already had numerous employees and more than a million sales.

A sole proprietorship will show you the ropes of what it means to run a business - but without all the financial and governmental complications of an LLC. You will be a business owner with no strings attached so to speak. Sure, you will have limited liability, but it allows you to start a business that can, later on, succeed as an LLC or a corporation.

Fees for the Business Entity Are Lower

Compared to any other type of business structure, the owner of a sole proprietorship does not have to pay as many fees. For example, if you are a sole proprietor, you will not have to pay as many registration fees as you would for an incorporated form of business.

Since you are the owner of a sole business structure, you  and your business have the same legal entity. This is why it is not necessary to register your business - mainly because you've already registered yourself as a sole proprietor.

The only exception here is if you use a name other than your own legal name for the business structure. In this case, you will have to register your business.

You can register your business name formally if you want to, as it may allow you to take a much bigger step in your professional career. However, if you don't have the funds to register now or you want to leave it for a later point, then sole proprietorship is at an advantage here.

Banking Is Quite Straightforward

With sole proprietorships, banking is quite straightforward. A sole proprietor does not have to open a business account, nor do you have to keep any promises to any financial institutions in regard to a business account. If it makes you feel any better, you may simply use your own bank account in order to handle your business expenses.

To make matters easier for you, you might still want to create a different checking account underneath your name. You don't even have to change your bank. Most banks allow you to open separate accounts online, so all you have to do is flip between them. This will make it much easier for you to keep track of your expenses, without too much of a headache.  

They Aren't As Heavily Regulated By the Government

When it comes to government regulations, sole proprietorships are less pressured. You must make sure that you have your trade license, and that you respect your local regulations. However, when it comes to government regulations and rules, you are not as constricted.

As the owner of a sole proprietorship business entity, you do not have to pay any corporate taxes. You can operate easily and quietly - something that you might not be able to do as the owner of a larger corporation.

What Are the Disadvantages of Sole Proprietorship?

While there are indeed many advantages of sole proprietorships, there are also a few drawbacks that you need to keep in mind. Here are the disadvantages of sole proprietorships:

You Are Personally Liable

One of the biggest disadvantages of sole proprietorships is heavily tied to the advantages these business owners reap. For instance, as a sole proprietor, you have full freedom to do what you want with your business, take any decision that you need or hire as many people as necessary.

However, with these types of business structures, you are also fully liable for everything you do. You are responsible for its financial aspects, and if your business goes south, you are also liable for the losses. Limited liability is one of the biggest benefits of incorporating.

As the owner of a sole proprietorship, you need to honor debt yourself, pay the contractors, pay wages, and cover insurance for your clients. All the legal contingencies are yours to handle.

For instance, if your small business gets sued for malpractice or you enter bankruptcy, your personal assets may be seized in order to cover the debt. This includes your car, your home, your bank account, or any other personal assets you may have.

This differentiates a sole proprietorship from the standard business structure, where the legal aspects are kept separate from your personal ones. As a result, if the company goes through difficulty, there's no risk that your personal assets will be seized.

Also, sole-proprietorship owners are liable for paying their own self-employment taxes. For instance, Social Security and Medicare - these are taxes that you will have to handle yourself.

Raising Money Can Be Difficult

The startup costs of this type of business are low, but one of the biggest disadvantages of a sole proprietorship is that raising money and capital can be difficult.

As you are liable for all the debt incurred by your business, you are responsible for paying everything else too. This includes suppliers, labor costs, overheads, and many more.

Since you'll have a lot to cover from your own business income, you may not have many chances to raise your capital. Your limited liability can make you vulnerable, and all your personal assets are tied to your business.

Selling May Prove Challenging

You may not want to think about the possibility of selling your business - but that doesn't mean it's not there. However, if you do have to sell your business, you might hit another wall: people may not be willing to buy sole proprietorships.

The reason behind this is simple. Sole proprietorships carry debt - and when someone buys this business from you, they buy your debt as well. If you have high debt or a high capital gains tax, it might be hard to sell the business.

It's Harder to Procure Business Credit and Financing

Owners of sole proprietorships may find it more difficult than others to obtain business credit. This is because LLCs and corporations have a certain legal distinction that makes them more reliable. Sole proprietors don't have that, which makes them less trustworthy in the eyes of creditors.

You May Find It Difficult to Track Your Expenses

The problem with a sole proprietorship is that most people use their personal accounts in order to make payments. On one side, it makes things easy, as you are using just one account.

On the other hand, your expenses get all mixed up. Whether you make a business or personal payment, everything will be listed on the same bank statement - and unless you have a clear description or receipt for that payment, you may not even know which is which.

With a sole proprietorship, you risk mixing your personal expenses with the business expenses, causing you to lose track. Also, when tax time comes, you might end up losing deductions (or deducting what you shouldn't) simply because you got confused.

Sole proprietors can indeed open a business account for this purpose, but very few of them actually do. This can cause financial troubles in the long run.

Tax Advantages of a Sole Proprietorship

Sole proprietorships have their own tax advantages when they file. The main advantage is in their simplicity, as there are fewer requirements in terms of business taxes.  

Business taxes do not have to be separated. You just have to report your business income along with your losses upon filing for a personal tax return.

As a sole proprietor, you will not be paying taxes for your entire business income. Instead, you will only pay taxes for any potential profit that you make. You won't be paying taxes for the income used on business expenses, which can actually help you cut down your losses.

The Bottom Line

Sole proprietorships have their advantages and drawbacks. If you find that the advantages outweigh the disadvantages, then this type of small business may be just the right thing for you. Just make sure you sit down and analyze the pros and cons carefully before making the decision.

Tom Smery
Tom Smery is a certified CPA for over a decade. In his free time, he writes articles to pass on his expert knowledge on taxes and accounting. Thomas has a wide range of deep knowledge on 1099 taxes, and finance topics. You can find him fishing when he is not preparing taxes for his clients or writing about accounting.

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