The most basic of all business legal structures is the sole proprietorship. For new start-ups, the choice of becoming a sole proprietorship is the simplest of all business forms but is it the best? Learn the pros and cons of a doing business as a sole proprietorship.
A sole proprietor is a business of one without a corporation or limited liability status. The individual represents the company legally and fully. Common proprietorship structures include part-time businesses, direct sellers, new start-ups, contractors, and consultants. This form of business has several advantages:
The Advantages of a Sole Proprietorship
- Quicker Tax Preparation: As a sole proprietor, filing your taxes is generally easier than a corporation. Simply file an individual income tax return (IRS Form 1040) including your business losses and profits. Your individual and business income are considered the same and self-employed tax implications will apply.
- Lower Start-up Costs: Limited capital is a reality for many startups and small businesses. The costs of setting up and operating a corporation involve higher set-up fees and special forms. It's also not uncommon for a lawyer to be involved in forming a corporation.
- Ease of Money Handling: Handling money for the business is easier than other legal business structures. No payroll set-up is required to pay yourself. To make it even easier, set up a separate bank account to keep your business funds separate and avoid co-mingling personal and business activities.
The Disadvantages of a Sole Proprietorship
- Personally Liable: Your small business in the form of a sole proprietorship is personally liable for all debts and actions of the company. Unlike a corporation or LLC, your business doesn't exist as a separate legal entity. All your personal wealth and assets are linked to the business. If you operate in a higher risk business such as manufacturing or consumables, the cost to benefit ratio is favorable toward a corporate structure.
- Lack of Financial Controls: The looser structure of a proprietorship won't require financial statements and maintaining company minutes as a corporation. The lack of accounting controls can result in the demise of your small business. No matter the legal structure of your business, take the time to set up the proper financial statements for your company.
- Lonely at The Top: Being a business of one can be lonely. All the decisions, actions, and results rest on you. Are you able to work alone and be productive? If not bring in a partner can be necessary for your small business survival.
- Difficult to Raise Capital: Imagine your business in 5 years. Will it still be a business of one? Growing your small business will require cash to take advantage of new markets and more opportunities. Outside investors will take your company more serious if you are a corporation.
Forming a Sole Proprietorship
From the IRS's perspective, your small business is a sole proprietorship unless you have registered it as a corporation or other business structure such as an LLC. Setting up your proprietorship often does not require registration of the business. If you are planning to use another name or business name to operate your company, state laws will require a trade name registration or filing of your company name.
Choosing the best business structure for your business will depend on a host of individual factors including your type of business, tax situation, industry liability, among others. Your choice of business structure will have legal and personal implications. Work with your business professional team of a lawyer and an accountant to determine the type of business structure best for you.