Advantages and disadvantages of sole proprietorship.
When you’re ready to start a business, you need to decide how you want to set it up. Learn about the advantages and disadvantages of a sole proprietorship to decide what’s best for your situation.
There are several different ways to set up a new business; with each having their own pros and cons — but one of the quickest and easiest ways to get started is with a sole proprietorship. Here’s what you need to know about the benefits of going solo.
What is a sole proprietorship?
A sole proprietorship is when one person owns an unincorporated business and pays personal income tax on the profits they earn from that business. The business and the owner act as one entity, which means they share a bank account, assets, taxes, and income. Of course, they share the bills and potential legal liabilities, too.
Operating a sole proprietorship is arguably the fastest and easiest way to start and operate a business, but it also comes with its share of difficulties. Here are some of the advantages and disadvantages of sole proprietorship.
Advantages of sole proprietorship.
There’s a reason why most businesses in the United States operate as sole proprietorships: They’re just easier. They don’t have many of the complications that come with other business types. Here are some of the main advantages of sole proprietorship:
1. Faster setup.
It doesn’t take much paperwork to start a sole proprietorship business. In fact, you typically don’t even need to register with your state. You basically start your business just by starting to do business.
Depending on the type of business you want to start, you might need other types of business licenses or permits from your local government (i.e., health inspections for a food truck) — but there’s far less paperwork when you start a sole proprietorship.
And since there aren’t any partners or a board of directors to worry about, you don’t need to complete an operating agreement like you would with an LLC.
Fewer business forms mean you can start working sooner.
2. Easier banking.
With a sole proprietorship, your bank account and your business’s bank account are one. You don’t have to open a special business checking account. Basically, if you currently have a checking account, you’re ready to handle your sole proprietorship finances.
3. Tax advantages.
Business taxes are never fun. But at least with a sole proprietorship, it’s a bit easier because you don’t need to file for an employer identification number (EIN) with the IRS. You can use your social security number to pay your business taxes, just like you would pay your personal taxes.
You have the option to apply for an EIN, but it’s not a requirement.
In fact, one of the major advantages of sole proprietorships is that you don’t even need to file specialized business taxes. Sole proprietorships are taxed as what’s called a pass-through entity. The business profits and losses are reported on your personal tax return, so you don’t have to pay taxes separately.
Disadvantages of sole proprietorship.
It might be easier and faster to set up a sole proprietorship, but that doesn’t mean there aren’t a few downsides. There are also sole proprietorship disadvantages that come into play when you and your business act as one entity. Here are the most common:
1. Personal assets are not separate from business.
It might be easier to have your business and personal finances combined, but there’s also a major downside that comes along with the union. It means anything that affects your personal assets will impact your business — and vice versa.
For example, if any financial, legal, or tax problems arise with your business, creditors could seize your personal assets, since you and your business are technically one entity. There are no legal protections to shield your personal assets from potential business-related issues, unlike some other types of business setups.
2. Can be hard to raise capital.
Most banks prefer to loan money to companies with established lines of credit. As a sole proprietorship, you technically don’t have a business line of credit if you don’t open a business checking account or business credit card — which aren’t required for a sole proprietorship. You will need to open a business line of credit if you ever want to get funding down the road.
Also, the entire business relies on the owner’s personal finances. If the owner makes a poor investment or makes bad financial choices, it will impact the business. This makes lending to sole proprietorships riskier, which is why it may be difficult to secure a loan and raise capital.
3. Harder to sell.
Sole proprietorships are attached to the owner. And since you can’t sell yourself, that means you can’t actually sell or even hand down a sole proprietorship.
If you decide you do want to sell your business, you’ll need to come up with another way to do it, like selling off your business assets individually or establishing a DBA (“doing business as”). Sole proprietorships might be easier to establish, but they’re much harder to sell if you ever decide to do so.
Other types of businesses.
Sole proprietorships might be the most common type of business, especially for small businesses, but there are several types of business entities in the U.S. such as:
- Partnerships
- Corporations
- S corporations
- Limited liability corporations (LLC)
Each type of business entity is structured in a different way and is allotted certain rights or protections when filed as such. For example, one of the main differences between an LLC and a sole proprietorship is that the LLC creates separate entities between the owner and business, granting the owner more liability protection.
Each type of business comes with its share of advantages and disadvantages. If you’re looking for a quick and easy way to start doing business, a sole proprietorship is a great option. However, before you make your final decision, do your research to choose the business type that’s right for your situation.
Frequently asked questions.
Can you change your business type later on?
Yes, you can change from a sole proprietorship to another business type at any time. It just involves completing some paperwork and registering your business with the government. The most common conversion is going from a sole proprietorship to a limited liability corporation (LLC).
Can you have business partners as a sole proprietorship?
No. By definition, a sole proprietorship can only be owned by one person. Even if you start a business with your spouse, only one of you can be the official owner.
Do you need an EIN as a sole proprietorship?
If you don’t have employees at your sole proprietorship business, you don’t need to get an employer identification number (EIN). However, you can always apply for one.
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