A sole proprietorship is a simple, one-person business that does not have to register with the state, which is unlike a corporation, limited liability company, or partnership. If you are earning money on your own, you may already have your own sole proprietorship without even realizing it. Common examples of sole proprietors include freelancers, repairmen, artists, small vendors, etc.
If you’re a small business owner who has not chosen to incorporate your venture, don’t worry, you’re not alone. According to the Small Business Administration, over 70 percent of businesses in the United States are owned and operated by sole proprietors. Maybe you’re considering incorporating your business, but you want to make sure it’s the right step. Here’s an overview of the pros and cons of running an unincorporated business, also known as a sole proprietorship.
Advantages of a Sole Proprietorship
- Easier setup – It’s much simpler and less expensive to start a sole proprietorship than starting a formal corporation. From the moment you start doing business, you are a sole proprietor. If you don’t hire employees or set up a retirement plan, you won’t even need to bother applying for an Employee Identification Number (EIN) from the IRS. Simply put, you are your business and you’re entitled to all profits and responsible for all debts and liabilities.
- However, it should be said that sole proprietorships sometimes do require formal paperwork. Some states require sole proprietorships to file for a business license, and your type of business may require a type of locally-issued permit. Also, if you conduct business using a name other than your legal name, you will most likely need to register your business name as a “fictitious business name” with your local county or state government. To learn more about what your state requires, check out this 50-state guide to sole proprietorships
- Easier Operations – Unlike other business formations, a sole proprietor can comingle business and personal assets, making it less complicated to maintain the funds and associated bank accounts. The sole proprietorship does not have a separate identity under the law, so you don’t need to create a separate bank account and your customers can write checks to your name.
- More Control – A sole proprietor has complete control and decision-making power over the business, which is unlike business formations that require meetings with shareholders or partners. And in the event you want to move onto something new, a sole proprietorship offers the liquidity to shut down the business without much notice or easily sell the business without the formalities that come with selling a corporation.
- Tax benefits – Because a sole proprietor pays taxes on income from the business as part of his or her personal income tax payments, he or she avoids corporate tax payments.
Disadvantages of a Sole Proprietorship
- Increased liability – Without formally incorporating, the business owner will be held directly responsible for any and all debts, losses, and obligations of the business. This extends to any liability incurred as a result of acts committed by company employees. This reason alone is why many business owners choose to incorporate. Imagine hiring an employee who makes a bad call that results in a losing lawsuit. Without enough funds from the business to cover the legal expenses, you are forced to use your personal assets, so you sell your home, clean out your bank accounts, and dip into your retirement funds. In contrast, members in a formal corporation share only limited liability and cannot be held personally liable for losses or violations.
- Harder to secure capital – A lack of formalized incorporation is a deterrent to investors. Sole proprietorships do not issue stocks like corporations do, making it difficult to generate capital. Banks are also less willing to provide loans to sole proprietorship because they are often perceived as less dependable when it comes to repayment.
- Lack of continuity – When a sole proprietor dies, the business no longer exists. Even if the assets pass to the sole proprietor’s heir, that person will have to start a new business by filing for new licenses and tax numbers, re-registering the name, etc.
- Tax disadvantages – Though we mentioned that there are tax benefits to this type of business, it isn’t a surefire IRS win. Because the IRS views the business and business owner as the same entity, the owner must pay self-employment taxes and cannot deduct benefits that would normally be deductible for a corporation, like employee’s health insurance premiums. For more information about the types of taxes that must be paid by sole proprietors, check out the IRS Sole Proprietorships website.
If you decide you want to incorporate your business, read Bond Street’s basic guide to business formations to choose which entity is best for your venture.