5 Sole Proprietorship Pros and Cons

The benefits of sole proprietorship are that the business owner can take on more risk than a corporation. The risks include not having any liability beyond their personal assets, and potential smaller earnings/profits. There is also no limit as to how many people can share in ownership of the business:

The “10 disadvantages of sole proprietorship” is a list of the downsides to running a sole proprietorship. The pros and cons are listed in order from the most significant downside to least significant downside.

A sole proprietorship is a one-person company that has never been properly established with the state. The advantages and disadvantages of a sole proprietorship are that it is simple to start up, but there is no separation between the company and the owner, and there is no liability protection. Sole proprietorships are less expensive to establish, but they don’t protect you from personal responsibility.

It’s critical to keep your business and personal money separate, regardless of how you set up your company. Having money in the same account may cause major accounting, tax, and liability issues. Chase came out on top in our analysis of the finest business banking choices. A $300 incentive is available to new clients.

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Pros and Cons of a Sole Proprietorship

The Advantages of a Sole Proprietorship

The simplest sort of company to start is a sole proprietorship. It does not need any formal setup, yearly management, dedicated company taxes, or official record keeping. In a sole proprietorship, you just begin selling products or services, and you are personally responsible for any costs and obligations. All company revenue is treated as pass-through income and must be reported on your personal tax returns.

A solitary proprietorship has five advantages:

1. Low-cost and simple setup

There are no papers or paperwork to do when you establish a sole proprietorship since it is not a formal company structure. You don’t have to pay any incorporation or filing costs to get started. You may require a particular license, permit, surety bond, or business insurance coverage depending on your sector, but you don’t have to file any paperwork with the state.

Sole proprietorships are ideal for cottage industries and seasonal firms because of their simplicity of formation and minimal administrative/management costs. Use a sole proprietorship until your firm is established and expanding if you’re just starting out in a new enterprise – particularly one that doesn’t have a lot of liability.

Because owners aren’t taking the effort to properly incorporate, which would give liability protection and other benefits, sole proprietorships are simple to start up. Sole owners are exempt from these requirements, but they forfeit the liability protection provided by a formal corporate structure.

If you want to limit your responsibility, using a firm like Rocket Lawyer to form an LLC may be the best option. They’ll assist you with the state and federal paperwork, allowing you to legally separate yourself from your company.

Go to Rocket Lawyer for more information.

2. No double taxation or corporate business taxes

As a single proprietor, you don’t have to pay the same 21% corporate tax on company income as a C-corporation. Instead, you simply continue to file your personal tax returns and claim any additional company revenue as pass-through taxes, which means that all income is taxed at your regular income tax rate. State franchise or excise taxes are often waived for sole proprietors.

These exclusions make taxes for sole proprietorships considerably easier – and cheaper – than for corporations, where income is taxed first at the corporate level and then again when profits are given to shareholders in the form of dividends. The current dividend tax rate is between 15-20%, which means you might pay as much as 41% on your taxable company gains, not including the income tax you pay on your wage.

However, sole proprietorships aren’t the only kind of firm that may profit from pass-through taxation. Pass-through businesses, such as LLCs and S-corporations, avoid double taxation and the corporate tax rate on earnings. However, depending on where and how they operate, LLCs are frequently subject to franchise or excise taxes, which means that taxes may still be greater than a sole proprietorship, depending on profit levels.

As a single owner, you may be subject to the following taxes:

• Ordinary income tax – You don’t pay yourself a wage as a single entrepreneur. Instead, all gains are reported on your personal tax return and taxed at the same rate as your regular income.
• Self-employment tax — If you own and operate your own firm, you will be required to pay self-employment tax, which is the employer share of FICA tax. This implies you’ll have to pay an extra 7.65% in taxes, or the whole 15.3-16.2 percent in FICA taxes.
• Sales tax — If you’re selling items, you may be required to collect and pay sales tax, which varies by state but normally runs from 6 to 9 percent.

3. There aren’t any annual reports or filings.

To keep current, sole proprietorships do not need to file yearly reports or filings with the state. In actuality, you are only required to submit your individual tax returns. In contrast, LLCs, S-corporations, and C-corporations are normally obliged to produce yearly reports after they’ve been founded. Typically, these reports need revising member or management lists.

If you elected to form an LLC, LLP, S-corporation, or C-corporation instead of a sole proprietorship, you’d have to file a lot more paperwork, including:

• When you officially start a corporation, you must file an initial filing.
• Most states charge an annual filing fee to keep your business up to date.
• Change of management – You must inform the state whenever you change managers or directors.
• Members’ list – Many kinds of businesses are required to inform the state when their members change.
• Annual audit – Some businesses must submit annual audits.
• Company tax returns – Some businesses are obliged to file corporation tax returns and pay separate taxes on their earnings.

The lack of an annual file for sole proprietorships is advantageous not only because it saves you time and headaches, but also because most states levy a price for these yearly filings, which may vary from $50 to $200 or more. Sole proprietors, on the other hand, only need to submit their tax returns once a year.

4. There are no formal business structures that limit you.

Other, more formally constituted firms confront operational constraints in addition to regulatory restrictions. These restrictions do not apply to sole proprietorships. If you’re a single proprietor, you’re in charge of your own company and may make whatever choices you want as long as they’re lawful. There is no official approval or review procedure.

As a single owner, you are exempt from the following rules that apply to other kinds of businesses:

• Yearly meetings – Limited liability companies (LLCs) are obliged to have annual meetings to evaluate their management and membership lists.
• Board meetings – Some firms demand that certain business decisions be officially authorized by the company’s directors.
• Recorded minutes — For LLCs and companies, formal minutes must be maintained for these meetings.
• Shareholder votes – Any official acts taken by the firm, such as the appointment of management or the admission of new members, must be voted on by the shareholders.
• Formal evaluations — The company’s activities must be formally examined, and management must be re-appointed.

5. Keeping Records Is Simple

In an LLC or other properly constituted firm, you must keep your personal and business money separate. Otherwise, you run the danger of “breaching the corporate veil,” which exposes you to infinite responsibility. However, one of the many advantages and disadvantages of a single proprietorship is that limitless liability is always present.

Many lone owners do not separate their finances since they have limitless liability. They transfer company profits directly into personal accounts, pay personal expenses and obligations, and treat the business as if it were an extension of their own finances. This might make running a single proprietorship more straightforward than running an LLC or anything like.

Keeping business and personal funds together, although convenient, is not usually suggested. Keeping separate records allows you to keep a better eye on your company’s financial flow. Opening a company checking account is the first step towards segregating money.

Separating money in a sole proprietorship won’t insulate you from responsibility, but it will aid with accounting as the firm expands. It will also make transitioning to an LLC or another legal company structure simpler. We looked at the best business checking accounts and ranked Chase first. Bonuses are available to new clients.

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5 Drawbacks of Owning a Sole Proprietorship

It’s critical to weigh the benefits and drawbacks of being a single entrepreneur. The major disadvantage is that a business owner’s liability is limitless, and he or she may be held personally liable for the company’s obligations. You won’t be able to recruit W2 employees (only 1099 contract workers), which might be a major issue if you want to expand your company.

The following are some of the major drawbacks of sole proprietorships:

1. No Limitation on Liability

You don’t have the limited liability protections afforded by an LLP, LLC, S-corporation, or C-corporation if you’re a single proprietor. If someone is injured on your property or is damaged by a product of your company or a mistake you make, you are personally accountable for all business expenditures and obligations. This indicates that there is no legal distinction between you and your company.

In a sole proprietorship, you’ll be individually liable for the following liabilities:

• Expenses that your company has incurred
• Debts owed to a company
• Liability for a product
• Injuries caused by property
• If you give poor or inadequate service, you might face civil penalties.

A vendor, client, or lender may come after your personal assets to fulfill any liabilities of the firm since you have limitless personal responsibility under a sole proprietorship. LLCs, S-corps, and C-corps, on the other hand, construct a liability shield between a firm and its owners.

The personal assets of business owners are safeguarded under an incorporated entity such as an LLC or C-corp. They can’t be used to meet a company’s commitments by lenders, customers, or suppliers unless the owners do anything that permits the corporate veil to be penetrated or if the owner intentionally signed a personal guarantee. If you require legal protection, a single proprietorship is not the best option.

To incorporate as a single-member LLC, use a service like Rocket Lawyer. This should shield you from your company’s responsibilities. If you go there right now, you may have legal papers in your hands in a matter of minutes.

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“A limited liability corporation (LLC) protects your personal assets from creditors and litigation brought against the firm. Unlimited liability firms include sole proprietorships, most general partnerships, and other unincorporated enterprises. Because the company and the owner are the same in these enterprises, you’re responsible for the company’s obligations, even if another partner takes them on.”

— Josh Zimmelman, Westwood Tax & Consulting President

2. There isn’t any ongoing business.

If you set up your company as an LLC, C-corporation, or other legal structure, and anything happens to you (such as death or a planned departure), the company will continue to operate. In reality, if you keep your business records up to date and maintain correct licenses, your company may last indefinitely. However, if you’re a single owner and anything happens to you, your company is over.

There is no framework in a single proprietorship to ensure continuation. An employee or family member may keep working for you, but they’d be effectively establishing a new firm from beginning – they wouldn’t be carrying on your operations. This makes long-term planning and succession planning around your ultimate company departure, if any, more difficult.

In addition, sole proprietorships are unable to recruit full-time or W2 workers. You may still engage 1099 freelancers to conduct work for you, but you won’t be able to pay them or keep them long-term. You’ll need to incorporate as an S-corporation or a C-corporation if you want to recruit staff in the future. Check read our post on the differences between employing W2 and 1099 staff to learn more.

3. Raise Capital Is Difficult

If you want to acquire money from outside investors, establishing your company as a sole proprietorship is not a smart option. Because there is no genuine company to sell, raising funds is very hard unless you have physical assets or intellectual property that investors can invest in.

There are no equity shares in sole proprietorships, and they are not technically licensed firms. There is no official review or approval procedure for business choices. In a single proprietorship, “shareholders” have basically no rights. Investors are often wary of sole proprietorships because of these problems.

Even an LLC makes it difficult to obtain funds, however you may decide to become an S-corporation, which makes it simpler. A C-corporation, however, is your best choice if you want to raise money, particularly from an angel investor or venture capital company.

4. Incapable of taking on business debt

A sole proprietorship is not eligible for a business loan since it is not a properly incorporated firm. Instead, all debt is personal debt, including monies borrowed to expand or manage a company. Lenders will need any loans to be personally guaranteed by a single proprietor, which means they will be able to seize your personal assets if you fail.

This is due to the fact that a sole proprietorship is not a separate business entity – you are the company. By personally guaranteeing a sole proprietorship’s debt, you are promising lenders that you will return any loans obtained for business reasons, even if the company fails.

This, however, may not be that unlike from other sorts of corporate arrangements. Even if you form an LLC, you’ll almost certainly be required to personally guarantee any sort of company loan, including an SBA loan. When taking on business debt, make sure you understand your personal responsibilities.

5. An impression of a lack of professionalism

Customers and business associates sometimes see solo owners as unprofessional. This may not be an issue for folks who just wish to operate a small company out of their home or generate some additional money in their leisure time. However, while determining what kind of company structure to adopt, it’s important to weigh the advantages and disadvantages of a sole proprietorship.

C-corporations, which are at the opposite end of the spectrum from sole proprietorships, are employed by many of the world’s biggest enterprises and are often regarded as the most professional. These organizations have the most stringent organizational structures and monitoring requirements, but they also provide the best liability protection and the best opportunities for acquiring outside money.

Sole proprietorships, on the other hand, have no formal management or supervision structure. A solo proprietorship is basically someone who sells items or works for themself. When solo owners receive money, it is often sent to them directly. Their personal accounts are regularly used to pay bills.

Some of this sloppiness may be mitigated by opening a small business checking account in your company’s name. Many providers will let you use an alias or a “doing business as” name for your company (DBA). This, however, will differ per institution. Check out our post on the Best Small Business Checking Accounts for additional information.

Examples of a Sole Proprietorship

The advantages and disadvantages of sole proprietorships make them appropriate for small-scale entrepreneurs who are just getting started in low-cost, low-risk operations. It’s also preferable for business owners who don’t have a lot of assets that a creditor may take if the company goes bankrupt.

Here are a few instances of sole proprietorships:

Businesses on Amazon

Many individuals start Amazon enterprises by white labeling pre-existing items. As a single owner, you may simply do this. Read our post on how to sell on Amazon for more details.

Shops on Etsy

To avoid the costs of establishing up and running a legal company unit, many Etsy sellers operate as single proprietors. Read our post on how to sell on Etsy for more details.

Other Personal Enterprises

A sole proprietorship may be used for a variety of different enterprises. On sites like Fiverr or Upwork, independent service providers such as massage therapists and consultants may be ideally suited for single proprietorships.

Even a tiny lawn mowing or snow shoveling business in the neighborhood might be a viable candidate for a single proprietorship. However, before purchasing trucks or other equipment, you should transfer to a firm with liability protection. For example, switching to an LLC or S-corp might assist insulate you from personal responsibility in the event of an incident.

If their firm is just a part-time hobby or a tiny weekend operation, some small business owners want to remain sole proprietors. They may save money by not having to form or manage an LLC or other business. Those that expand, on the other hand, ultimately opt for a more formal structure that protects them against responsibility.

Alternatives to Starting a Business as a Sole Proprietorship

There are a variety of business structures that may be used instead of a sole proprietorship, such as:

Limited Liability Corporation (LLC) (LLC)

LLCs are the most straightforward to set up and manage. They may be made online in most states in as little as 5-10 minutes for $150-$200. LLCs provide business owners limited liability protection, but they also need yearly filings, updated member lists, tax filings with K-1s for members, and more formal management.

Limited Liability Corporation (LLC) (LLP)

Limited Liability Partnerships may only be used to practice a licensed profession in a few states. They are considered pass-through businesses for tax reasons, with tax responsibility being passed on to owners depending on their ownership position.

LLPs are similar to LLCs in that they may only be utilized in particular businesses, such as:

• Accounting
• Architecture
• Law

S-Corporations

S-companies are tightly owned corporations that are considered as pass-throughs in most cases but get unique tax status in others. While the IRS does not recognize LLC owners’ authority to pay themselves a compensation, S-corporation owners may pay themselves a salary and deduct it from business earnings.

Read our page on S-corps and C-corps for additional details.

C-Corporations

A C-corporation is the most durable and also the most expensive of the many corporate types. This is primarily due to the fact that C-corporations face double taxes, with corporate earnings being taxed at a rate of 21%. Once gains are transferred to business owners in the form of dividends, they are taxed a second time, this time at the owner’s individual income tax rate.

Read our page on C-corps and S-corps for additional details.

Who Should Form a Sole Proprietorship?

The benefits and drawbacks of sole proprietorships make them ideal for a young company owner just getting started. They should ideally be joining an area that does not carry a lot of risk or demand a lot of money to get started. They shouldn’t have to borrow money for the company or risk being hurt. A small-scale business would be excellent.

Sole proprietorships are also ideal for company owners who don’t have significant assets that may be confiscated by creditors, suppliers, or customers as a result of debts or obligations incurred in the course of doing business. This sort of company is ideal for an entrepreneur who just wants to get their firm up and running before moving on to a more official structure.

Most Commonly Asked Questions (FAQs)

1. What Are the Benefits of a Limited Liability Company Over a Sole Proprietorship?

The most significant benefit of an LLC over a single proprietorship is that it restricts your responsibility as a company owner. A solo owner is accountable for all of their company’s debts and liabilities. Company assets and personal money are separated under an LLC, and you are personally accountable for business commitments only if you give a personal guarantee or do anything that allows “piercing the corporate veil.”

2. Why Is Being a Sole Proprietor Beneficial?

Because sole proprietorships are simple to set up and cheap to operate, they may be particularly beneficial for some small or new enterprises. Unfortunately, many companies fail, therefore beginning as a single proprietorship might be a smart choice until you know whether or not your firm will flourish. This is particularly true if you’re launching a firm that doesn’t need a lot of outside funding or involves a lot of risk.

3. Is It Necessary to Register as a Sole Proprietorship?

No, registering as a single owner is not required. Depending on your industry, you may be required to register for particular licenses.

4. As a sole proprietor, how do I pay my taxes?

All you have to do if you run your firm as a sole proprietorship is maintain paying your personal taxes. Claim and pay self-employment tax on any income you make from your company activities. Depending on where your company is situated, you may also be required to collect and pay state and local sales taxes on any products sold.

Conclusion

A sole proprietorship is a fantastic, informal company structure with several advantages for small business owners. It’s critical to weigh the advantages and disadvantages of a single proprietorship before deciding on a company structure. While these firms do not provide liability protection for their owners and make it difficult to acquire funds, they are also very simple to set up and run.

If you combine company and personal finances as a single proprietor, you may face tax and liability concerns in the future. We propose opening a business checking account with Chase, which has low pricing structures and a bonus compared to other providers. Get started right now with no money required!

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