What Is a Sole Proprietorship?
A sole proprietorship is an unincorporated business owned by one individual, making it the simplest form of business to start and operate. There are over 20 million sole proprietorships operating in the United States and Canada, making it by far the most popular form of business ownership.
The key feature of the sole proprietorship definition is that unlike an incorporated business or a partnership, there is no legal separation between the business and the owner in a sole proprietorship -- the business is considered to be an extension of the owner, and as such the owner is personally responsible for any debts or liabilities incurred by the business.
Advantages of a Sole Proprietorship
A sole proprietorship is the easiest and least expensive form of business to set up and operate. If you operate your business under your own name, with no additions, you don't even need to register your business name to start operating as a sole proprietor. This makes the sole proprietorship ideal for business startups, self-employed contractors, and part-time and home-based businesses.
As a sole proprietor, you own 100% of the business and get to make all the decisions. Unlike corporations, sole proprietors are not required to hold shareholder's meetings or take votes on management issues.
Hours on Your Schedule
A sole proprietor can manage their own schedule and hours of operation (depending on the requirements of the customers). Depending on the type of business, the work environment can be tailored to the requirements of the owner.
Simpler Taxes and Accounting
Sole proprietorships are much simpler to operate from a tax and accounting perspective. As a sole proprietor, you do not need to file a separate business tax return -- all income generated from the business is reported on the personal tax form. The business owner receives all profits directly.
As with other forms of business, as a sole proprietor, your expenses related to the cost of doing business are fully deductible from income tax, as are travel expenses, automobile expenses, advertising, and a portion of your home expenses if you are operating a home-based business.
Deductible Business Losses
Business losses can be deducted against other forms of income or carried forward or backward, so a sole proprietorship that loses money in the early years can deduct the losses against personal income, making it ideal for those wishing to transition from employee to self-employed over a period of time.
Disadvantages of a Sole Proprietorship
Being self-employed in a sole proprietorship can seem like being stranded on a deserted island. It often means having no employees or partners to discuss business issues, explore new ideas, or interact with on a social basis. There are other significant downsides too.
No Legal Separation
As mentioned above, with a sole proprietorship there is no legal separation between you and the business. This means that if the business fails and incurs debts your personal assets—including your home and any other assets registered in your name—could be seized to discharge the liabilities (which can be unlimited). Likewise, if you are sued for damages caused by accident or negligence in the course of your business activities, your personal assets can also be seized.
Exposure to Liability
If your business activities could expose you to substantial liability a sole proprietorship is probably not a suitable form of business. With an incorporated business or partnership, the personal assets of the owner(s) are separate from the assets of the business and as such are protected from seizure for debt obligations or liability. As with all forms of business, having sufficient business insurance is very important.
Business Income Reports as Regular Income
While tax simplicity can be an advantage for sole proprietorships, it can also be a disadvantage in terms of flexibility, as all business income must be reported as regular income in the year in which it was earned. Incorporated companies have much more flexibility in terms of how and when the owners are paid.
Difficult Getting Contracts
Some businesses, government agencies, consulting groups, etc. will not deal with unincorporated businesses, either because they view a sole proprietorship as not having the same level of legitimacy and professionalism as an incorporated business, or that hiring a sole proprietor increases the risk of the tax authorities treating the person as an employee rather than an independent contractor.
Harder to Raise Capital
Raising capital is more difficult for sole proprietorships. Incorporated companies can raise equity financing from angel investors or venture capitalists by selling shares in the business.
Difficult to Sell the Business
Sole proprietorships can be difficult to sell as the business is completely tied to the owner. Since there is no distinction between the assets of the owner and the assets of the business, the proper valuation of the business can be hard to achieve. Death of a long-term illness of the owner can render the business worthless. Customer loyalty resides with the original owner of the business and may not readily transfer to a new owner.
Unless the sole proprietor has friends or family members who can carry on running the business, illness or injury can affect business continuity. Depending on the workload, it can also be more difficult to get time off for vacations or family issues.
Famous Businesses That Began as Sole Proprietorships
It should be noted that you don't have to keep the same form of business ownership for the life of a business. Many small businesses start out as sole proprietorships and then become corporations later as shown in the following examples.
J. Willard Marriott started several businesses as a sole proprietor, beginning with a root beer stand that eventually became the A&W restaurant chain. His hotel business began in 1959 and did not incorporate until 1969.
Richard Warren Sears started a mail-order watch and jewelry sales company as a sole proprietor. He later hired Alvah Curtis Roebuck to repair watches. The two decided on a partnership and eventually, Sears, Roebuck, and Company became the largest retailer in the United States.
James Cash Penney started his career as an employee in a small retail chain in 1898. He eventually bought out the existing partners and ran the business as a sole proprietor for a number of years. The number of stores continued to grow and in 1913 the chain was incorporated under the name "J.C. Penney Company." By 1929 over 1,000 stores were in operation.