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.
Sole 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!
Sole 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.
Sole 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.
It’s Easy to Start and Easy to Leave
Small 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.
The 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 Status
Since 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 Resources
Another 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?
Starting a solo business is by no means easy, but it is an extremely rewarding experience. An entrepreneur has complete control over their venture; they are able to mold and shape this new world into whatever they see fit.