How Do Sole Proprietorships Work?Starting a sole proprietorship is a fantastic alternative to traditional business ownership. A sole proprietorship is defined as a business that is owned and operated by one individual, with only themselves as an employee. Sole proprietorships are sometimes referred to as microbusinesses or lifestyle businesses because they typically don't require any kind of formal training or significant investment.While very popular, this type of entrepreneurship venture does come with disadvantages such a lack of external funding (bank loans) and investors who might be willing to take losses now to gain future dividends. Before starting your own sole proprietorship, it is important to understand the benefits and difficulties of this type of business in order to make the best decision.
IndependenceSole proprietorships are great because the business owner has complete control over decisions concerning the business and can utilize any profits as they see fit without seeking approval from a board or investor group. The independence of a sole proprietorship gives the owner the opportunity for more creative endeavors without having to wait on board approval meetings or shareholder votes. If you don’t want to answer to anyone else and want only an 18% self-employment tax and no overhead, a sole proprietor may be the way to go!
FlexibilitySole proprietorships have fewer regulations than in a corporation. By starting as a sole proprietor, you can always convert to another business structure that best suits your needs. For instance, if you have a customer base that demands an e-commerce website, you can incorporate and maintain your customer base through the website.
They’re InexpensiveSole proprietorships require little capital upfront, with most costs starting at $0. Another benefit of sole proprietorships is that so long as your business has significant revenue, it will be exempt from taxes until it reaches 250k in revenue annually. That gives you a lot of room to work with before taxes kick in.
Lowered Company CostsBudgets might be limited when a business is being established and being operated. Therefore, being able to avoid paying registration fees is another important benefit of operating as a single proprietor.State registration is a prerequisite for conducting business for LLCs and other business entities, as we discussed above. In order to keep their registration, LLCs must often pay an annual fee, which adds up quickly. Fortunately, sole proprietorships are exempt from these ongoing legal requirements, so compared to other business structures, you'll save on these costs (as well as the time and hassle).
Uncomplicated bankingOne of the next important advantages of a sole proprietorship is simplified banking. The only type of business entity that doesn't need a business checking account to run a firm is a sole proprietorships. (Though many of the personal financial safeguards that come with holding an LLC are invalidated if you operate it without a corporate bank account.)You can send and receive payments for your firm as a sole proprietorship directly from your personal bank accounts. You are not required to open a business checking account, however you do have the choice to do so if you wish to keep your personal and professional finances separate.In the end, all you really need to get started with banking is your own checking account. Just make sure to keep detailed records that show the difference between your personal and business expenses.
It’s Easy to Start and Easy to LeaveSmall business owners who choose sole proprietorship can make a living without the need for a degree, license, or even a job. Paperwork is limited and the owner can take care of it all easily by themselves. This can make them a great entry point for those without much business experience, and it provides the opportunity to scale up more or less quickly, depending on the owner’s needs and skills.Undoubtedly, sole proprietorships make it simple to launch a business. But they also make running a business easier.You don't have to worry about some of the other elements contained in an LLC or corporation, including corporate officers or registered agents, with a sole proprietorship. You have complete control over decisions, finances, and every aspect of how your organization runs as the single proprietor.As a result, you can concentrate on your daily operations and long-term goals without having to involve other stakeholders or deal with managing external personnel to keep your company on the right side of state and local registration. You also don't have to worry about boards, officers, or any of the other positions typically required by other business structures.Along these lines, you gain a degree of privacy and independence that you won't find with conventional business forms as you don't need to publicly register your firm. One advantage of operating as a single proprietor is that you have complete control over how your firm is run because you are not subject to the same disclosure or reporting requirements that corporations or LLCs are.
Reduced PaperworkTo clarify, before you can conduct business with other business entities, including limited liability corporations, you must register with your state's government. Contrarily, with sole proprietorships, you often do not need to register with the state; rather, you automatically become a business entity by virtue of conducting business.The laws of your state or local government may require you to seek a business license or permission, so it's crucial to keep that in mind. However, one of the early advantages of being a single owner is that you may scale up your business much more quickly and with less burdensome paperwork from the government.
LiabilityThe main disadvantage of this type of business stems from the fact that sole proprietors are personally liable for any debts incurred by the business. This is a serious drawback, as personal assets might have to be liquidated in order to pay off debt. There's no limit on the amount of liability you can assume in a sole proprietorship because there's no separation between your finances and your business' finances.
Lack of Legal StatusSince you're self-employed in a sole proprietorship, there's no legal entity to shield you from lawsuits and other types of liabilities that may arise. If you get into legal trouble with your business, you’ll have a lot more work to do than if you were an employee for a company with its own legal team.
Lack of Financial ResourcesAnother disadvantage of starting as a sole proprietor is that if you don't have enough money for equipment or inventory to get started in the first place, you might never be able to get off the ground. Other businesses can take advantage of outside financial support in the form of loans or investors, but sole proprietorships are on their own until they get more established. It’s usually fairly difficult to find financial backing when putting a sole proprietorship on the market for the first time.
Before Starting Your Own Sole Proprietorship, Ask Yourself:
- Are there significant overhead costs?How expensive will your initial supplies and materials be?
- Do I have enough funding for at least six months without any income?If you’re giving your sole proprietorship your full attention, you probably won’t have an outside job for income.
- Do I have enough money for contingencies?What are some potential problems you could face, and are you prepared to handle them if they occur?
- Do I have adequate funds for marketing and advertising?How will you get the word out about your new business so that you can start to make some income?
- Is my main revenue stream capable of generating enough revenue to cover all these expenses?Where are you getting your startup money? Will you keep getting income from that source? Do you have backup streams in place if you were to lose your income source?