Sole proprietorship is a specific legal term used to describe an unincorporated business owned by a single person. There are many benefits of sole proprietorship. It is the simplest and most straightforward of all the business entities, it is also the most common type, and it offers significant advantages.
If you’re considering starting your own new business and you’re trying to decide between sole proprietorship and other business structures, here’s what you need to know.
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Of all the different business structures available — sole proprietorship, partnership, limited liability company, and corporation —a self-employed sole proprietorship is the one that is easiest to establish and operate. It provides the individual owner with total control of how they operate their business, with nobody to report to or to whom they need to justify any of their decisions. All the profits of the business go directly to the owner. Read our guide on how to pay yourself as a sole proprietor.
There are no stakeholders other than the single individual who owns the business, though a sole proprietorship can hire employees. Examples of sole proprietorships can be retail shops, home-based businesses, consultancies, professional service providers, and freelancers to name a few possibilities. In all cases, the owner is inextricably linked and associated with the business itself. The two are as one.
Sole proprietorships provide no separation between the owner and the business, either from a tax perspective or a personal liability perspective. Sole proprietorship businesses operate as pass-through entities. This means that all revenue and profits belong to the owner and get reported on their personal tax return.
Not only is the owner directly responsible for paying and filing taxes on the business’ income, they are also responsible for paying all employee wages and have no personal protection from their business's debts or legal liabilities.
There are few things more exciting than opening your own business, but the prospect of doing so can also be daunting. For some, entrepreneurship was never an if or a what, but rather a when. They have a skill or an idea and simply need the running room and the opportunity. Others have long wanted to be their own boss — or may have an absolute aversion to working for somebody else — but don’t even know how to start or what service or product to sell.
Whichever of these scenarios best describes you, once you’ve overcome your initial obstacles and are ready to start, your next step is to choose a business structure. Choosing sole proprietorship as your business structure offers tremendous simplicity and ease. From a paperwork perspective, sole proprietorship requires absolutely no formal action. There are no contracts, agreements, or registrations outside of the appropriate licenses associated with your operation or industry. That means no additional costs and more money in your pocket.
By comparison, a written agreement is highly recommended (though not required) when forming a partnership to formalize the management and contributions of money, profits, and responsibilities. Forming a limited liability corporation from a sole proprietorship or by itself requires that articles of the organization be filed with the state in which you operate, and an operating agreement is highly recommended. Incorporation requires principals to formally register articles of incorporation with the Secretary of State where your business operates.
Avoiding all of these complications is particularly advantageous if you are starting your business as a test run or are operating it in addition to having responsibilities elsewhere. You can start a sole proprietorship without spending too much time on bureaucratic tasks not associated with the business itself.
Some entrepreneurs spend hours dreaming up the perfect business name, but if you’re not hanging out a shingle or a sign above a storefront, having a novel name may be of little interest. As a sole proprietorship, you can simply use your personal name as your business's legal name, and that saves you from having to register a business name at the trademark office or file a Doing Business As with your local administration. It also saves you from the fees associated with each of these processes.
Because sole proprietorships are the same legal entity as their owners, the Internal Revenue Service treats them as pass-through entities. They pay using the owner's Social Security Number and do not need to use an employer identification number unless they have employees. The business pays no separate taxes and all income is reflected on the owner’s personal tax return and reported on their individual IRS 1040. There is no need to use any separate, unfamiliar forms, and the tax rate that sole proprietors pay is lower than that of any of the other available business entity types.
When a sole proprietorship is prepared to file taxes, they use a Schedule C to reflect all of their business’s income, expenses, and losses. They then transfer the pertinent total into their personal tax calculation and pay any taxes due accordingly. Notably, these owners are required to pay self-employment taxes and to submit quarterly estimated income taxes.
Just because the name of the business entity includes the word “sole,” you’re not required to operate it all by yourself. A sole proprietor can hire as many employees as they like to help them run their business. Of course, when they do so, they are personally responsible for paying wages, providing benefits, and withholding appropriate taxes on behalf of their employees.
Probably the single most important part of choosing to be a sole proprietorship is the ability to have complete control over every aspect of the business. Whether you’re a small business owner or your sole proprietorship grows to include multiple locations and hundreds of employees, as long as you continue to operate as a sole proprietor you are able to be the sole owner or decision-maker.
You can take time off whenever you’d like, make your own hours, devise your own operational and marketing strategies without fear of criticism or correction. Of course, that means that when you make mistakes you have nobody to blame but yourself, but if you are the type of person who chafes at taking direction, suggestions, or criticism, then you likely view the risks as worth the reward.
If you are looking to start a sole proprietorship, check out the best businesses to start with 5k.
Put simply, there are strengths AND weaknesses to a sole proprietorship. It would be a mistake to choose a sole proprietorship as your preferred business structure based strictly on the advantages that it offers. Smart entrepreneurs make sure they’re as aware of the cons as the pros of every decision that they make. As attractive as a sole proprietorship may be, there are several reasons to bypass its ease and opt for another entity type.
It’s tempting for a budding entrepreneur to make important business decisions based on assumptions of success, but not every small business succeeds, and not every entrepreneur’s story has a happy ending.
If a business fails to thrive, it may be left with big, unpaid bills for equipment or inventory. The owner may have signed a lease they can no longer afford, owe sales tax, or be committed to a business contract they are unable to fulfill. Without the liability protection offered by other business structures, a sole proprietorship business owner is personally on the hook for every commitment — to an unlimited degree.
Even more frightening is the fact that a sole owner is legally responsible for other liabilities that are assigned to their business. To get a sense of exactly what that means, imagine the owner of a restaurant or small retail shop where a customer or employee slips, falls and suffers serious personal injuries, or a business whose employee commits some type of negligent or irresponsible act that causes harm.
If the injured individual files suit seeking compensation for the damages they’ve suffered, the sole proprietor is personally responsible and faces the risk of losing their personal assets.
By comparison, business owners or sole proprietors who opt for a limited liability corporation or a corporate structure can see their business named as the subject of lawsuits or debts without risking their life savings. The business is a separate legal entity. The sole proprietor is also personally responsible for non-compliance with laws and regulations. Citations and criminal charges all get attached to their name rather than to their business.
Read more about a sole proprietorship vs a single member LLC.
Every business has its own capital requirements. A freelancer or consultant operating their business as a side gig may need nothing more than their laptop and phone to get started, while an aspiring coffee shop owner will need espresso machines, refrigeration, and a place to put them.
The more equipment and investment is needed, the more of a challenge it may be to remain within the framework of a sole proprietorship, as sole proprietorships have no stock or equity to sell.
In most cases, sole proprietorships rely on whatever cash savings they have available to them or loans from family members or friends. They may be able to take out a loan, but it would be in their own name and the terms would be dependent upon their credit rating and the risk perceived by the lender.
The owner might need to put up their personal assets as collateral, creating a real risk to their personal credit if the business fails and they find themselves unable to repay their debt.
No matter how successful a sole proprietorship business may be, should the owner die or for some other reasons become unable to continue, the business ceases to be. Where partnerships, limited liability corporations, and corporations each have structures that allow a business to continue existing, a sole proprietorship’s identity is directly tied to its owner.
If that heading seems familiar, it’s because you saw it earlier in this article, under the larger category of “advantages” of a sole proprietorship. For all of the freedom and satisfaction that comes with being independent of supervision, there are also significant stressors and burdens that come with being the boss.
In addition to having to pay self-employment tax, every decision and its outcomes rest entirely on the owner’s shoulders, and so too do all of the responsibilities. Unlike other business entities set up as partnerships, sole proprietorships that operate on their own may find it a challenge to take time off. Even having trusted employees often does little to alleviate that dynamic.
Running a business is not always a high-pressure situation, but it certainly can be. While success is obviously the goal, it is not promised Just as is true of the business's liabilities and income, a sole proprietorship’s failure passes directly to the owner as well.
If you are embarking on your own entrepreneurial journey, the benefits of a sole proprietorship are undeniable. The structure allows the fastest, easiest, and least expensive entry point to business ownership, with very few downsides.
One last consideration to keep top of mind is that sole proprietors have significant flexibility. As you become more established and profitable you may wish to expand the scope of your business. Likewise, concerns about personal liability or the need to attract capital investment may become a greater concern.
As the only decision-maker of a sole proprietorship, you will be free at any point to move your business from its unincorporated model to whatever type of legal entity is most appropriate and advantageous.
Starting your business venture as a sole proprietor and building a successful entrepreneurial track record gives you all the advantages of independence and simplicity along with the benefit of accumulating financial records and sales data that can help you attract partners, investors, and stakeholders in the future.
A verbal contract (formally called an oral contract) refers to an agreement between two parties that's made —you guessed it— verbally.
Formal contracts, like those between an employee and an employer, are typically written down. However, some professional transactions take place based on verbally agreed terms.
Freelancers are a good example of this. Often, freelancers will take on projects having agreed on the terms and payment via the phone, or an email. Unfortunately, sometimes clients don't pull through on their agreements, and hardworking freelancers can find themselves out of pocket and wondering whether a legal battle is worth all the hassle.
The main differences between written and oral contracts are that the former is signed and documented, whereas the latter is solely attributed to verbal communication.
Verbal contracts are a bit of a gray area for most people unfamiliar with contract law —which is most of us, right?— due to the fact that there's no physical evidence to support the claims made by the implemented parties.
For any contract (written or verbal) to be binding, there are four major elements which need to be in place. The crucial elements of a contract are as follows:
Therefore, an oral agreement has legal validity if all of these elements are present. However, verbal contracts can be difficult to enforce in a court of law. In the next section, we take a look at how oral agreements hold up in court.
Most business professionals are wary of entering into contracts orally because they can difficult to enforce in the face of the law.
If an oral contract is brought in front of a court of law, there is increased risk of one party (or both!) lying about the initial terms of the agreement. This is problematic for the court, as there's no unbiased way to conclude the case; often, this will result in the case being disregarded. Moreover, it can be difficult to outline contract defects if it's not in writing.
That being said, there are plenty of situations where enforceable contracts do not need to be written or spoken, they're simply implied. For instance, when you buy milk from a store, you give something in exchange for something else and enter into an implied contract, in this case - money is exchanged for goods.
There are some types of contracts which must be in writing.
The Statute of Frauds is a legal statute which states that certain kinds of contracts must be executed in writing and signed by the parties involved. The Statute of Frauds has been adopted in almost all U.S states, and requires a written contract for the following purposes:
Typically, a court of law won't enforce an oral agreement in any of these circumstances under the statute. Instead, a written document is required to make the contract enforceable.
Contract law is generally doesn't favor contracts agreed upon verbally. A verbal agreement is difficult to prove, and can be used by those intent on committing fraud. For that reason, it's always best to put any agreements in writing and ensure all parties have fully understood and consented to signing.
Verbal agreements can be proven with actions in the absence of physical documentation. Any oral promise to provide the sale of goods or perform a service that you agreed to counts as a valid contract. So, when facing a court of law, what evidence can you provide to enforce a verbal agreement?
Unfortunately, without solid proof, it may be difficult to convince a court of the legality of an oral contract. Without witnesses to testify to the oral agreement taking place or other forms of evidence, oral contracts won't stand up in court. Instead, it becomes a matter of "he-said-she-said" - which legal professionals definitely don't have time for!
If you were to enter into a verbal contract, it's recommended to follow up with an email or a letter confirming the offer, the terms of the agreement , and payment conditions. The more you can document the elements of a contract, the better your chances of legally enforcing a oral contract.
Another option is to make a recording of the conversation where the agreement is verbalized. This can be used to support your claims in the absence of a written agreement. However, it's always best to gain the permission of the other involved parties before hitting record.
Fundamentally, most verbal agreements are legally valid as long as they meet all the requirements for a contract. However, if you were to go to court over one party not fulfilling the terms of the contract, proving that the interaction took place can be extremely taxing.
So, ultimately, the question is: written or verbal agreements?
Any good lawyer, contract law firm, or legal professional would advise you to make sure you formalize any professional agreement with a written agreement. Written contracts provide a secure testament to the conditions that were agreed and signed by the two parties involved. If it comes to it, a physical contract is much easier to eviden in legal circumstances.
Freelancers, in particular, should be aware of the extra security that digital contracts may provide. Many people choose to stick to executing contracts verbally because they're not sure how to write a contract, or they think writing out the contract terms is too complicated or requires expensive legal advice. However, this is no longer the case.
Today, we have a world of resources available at our fingertips. The internet is a treasure trove of invaluable information, platforms, and software that simplifies our lives. Creating, signing, and sending contracts has never been easier. What's more, you don't have to rely on a hiring a lawyer to explain all that legal jargon anymore.
There are plenty of tools available online for freelancers to use for guidance when drafting digital contracts. Tools like Bonsai provide a range of customizable, vetted contract templates for all kinds of freelance professionals. No matter what industry you're operating in, Bonsai has a professional template to offer.
A written contract makes the agreement much easier to prove the terms of the agreement in case something were to go awry. The two parties involved can rest assured that they're legal rights are protected, and the terms of the contract are sufficiently documented. Plus, it provides both parties with peace of mind to focus on the tasks at hand.
Bonsai's product suite for freelancers allows users to make contracts from scratch, or using professional templates, and sign them using an online signature maker.
With Bonsai, you can streamline and automate all of the boring back-office tasks that come with being a freelancer. From creating proposals that clients can't say no to, to sealing the deal with a professional contract - Bonsai will revolutionize the way you do business as a freelancer.
Why not secure your business today and sign up for a free trial?