Posted 6 years ago in Small Business Tips by Tim Chaves
A sole proprietorship is a business that is owned and operated by one person. In a sole proprietorship there’s legally no distinction between the business owner’s personal assets and debts and the business assets and debts.
If you’re thinking about the best way to set up your business and you think a sole proprietorship is an option, here are some pros and cons to consider before you sign any papers.
Sole proprietorships make it easy for anyone to set up a business, no matter how few assets, or how little money you’re starting with. Every business has to start somewhere, and many of the corporate giants we see today started out as teeny tiny sole proprietorships.
Setting up a sole proprietorship doesn’t involve getting through a lot of red tape. There’s very little paperwork to prepare and submit, and the cost is minimal. When you’re creating a sole proprietorship, you don’t even have to decide on a separate business name. You can just do business under your own name.
To get started, visit your local government website to see the requirements (Ex: if you live in California, visit CA.gov, or if you live in Nova Scotia, Canada, visit novascotia.ca).
When you’re running a sole proprietorship, you’re not required to keep a separate set of books for the business. You simply include the proceeds and expenses from your business in your personal records and you’re good to go! No formal financial statements, no K-1 forms, or other partner statements required. Come tax time, you’ll be saving yourself a lot of time (and, possibly, trees) by having a sole proprietorship instead of a corporation.
Note: Even though you don’t have to set up separate books, it would probably be a good idea to have a separate bank account for your business. It’ll make it easier to track and budget for your business expenses.
Taxes: that dreaded word! But, when you have a sole proprietorship, that word may not strike as much fear in your heart. You’ll report your business profits as personal income, meaning you’ll be paying your personal income tax rate as opposed to a higher corporate tax rate. You’ll also be avoiding the double taxation that happens in C-corps, when the revenue is taxed at a business level, and then again when it’s disbursed to partners as earnings.
Do keep in mind that as a business you’ll still be subject to paying certain kinds of other taxes, like self-employment tax, and sales tax, depending on what you’re selling.
Being your own boss is one of the many up-sides of running a sole proprietorship. You have the last word on all decisions, you decide what to spend and when to spend it, you choose what to do with the business profits– in short, you call all the shots.
You want an extra week of paid vacation this year? Take it! You need a new piece of equipment to offer a needed service in your area? Buy it! You want to use some of your profits to invest in a separate business venture? Go for it! No waiting for upper management to respond to your requests, no partner to sign off on everything, no board of directors withholding their approval. Simple!
When you have a corporation or partnership, you’re governed by certain rules and regulations, like how your business is organized and structured. When you have a sole proprietorship, you don’t have to worry about any of that. You can organize, structure and run your business how you see fit, without the government getting too heavily involved in the details.
If the day comes that you decide you don’t want to be in business anymore, a sole proprietorship makes it easy to step away. Since you don’t have any formal regulations or restrictions, and no partners to come to terms with, it’s pretty straightforward.
Take care of any outstanding orders, contracts and debts, and then close your business accounts and let the IRS know that you’re shutting down operations. That’s it!
Maybe one of the biggest disadvantages of running a sole proprietorship is the fact that you are personally responsible for any losses and legal actions. Let’s say you incur a huge loss over a couple of years, and your creditors are calling you nonstop, trying to collect what you owe.
If you’re a sole proprietor, those creditors can go after not only the money in your business accounts, but anything you own personally that is technically separate from your business. Because, remember, with a sole proprietorship, there is no legal distinction between your personal and business assets and debts. If your business gets sued, you personally are being sued. If you lose a case, you are personally responsible.
If you’re worried about this and trying to decide on a sole proprietorship vs. LLC, an LLC can be fairly simple to set up and adds the limited personal liability you’re hoping for.
Since sole proprietorships don’t require much in the way of organization and structure, and are sometimes even run out of the owner’s home, they can be seen as less professional than corporations or partnerships of other types. Bills might be paid from personal bank accounts, the phone might be answered by the owner’s children, and business might be conducted from a walk-in closet under the stairs.
If you don’t need to project a certain image, then this may not be an issue. But, if you’re trying to attract clients and give the impression that you’re organized and trustworthy, this could be a stumbling block.
If you need to raise money from outside investors, then a sole proprietorship may not be the way to go. Unless you have a formal business, separate from your personal assets, that can be evaluated on paper, it’s tough to get people to give you money.
Investors will want to see financial statements so they know how the business is doing–so keep up with your bookkeeping by using an alternative to QuickBooks. They’ll also want your business to be something tangible that could be sold in the event things don’t go well, in order to recover all or part of their investment. When you have a sole proprietorship, there’s nothing to sell because it’s attached to you.
Sole proprietorships also often have a harder time getting banks to loan them money. They don’t often have the same resources as other corporations and partnerships do, so banks may see sole proprietors as a bigger risk. Consider alternative financing options, like PayPal working capital.
As mentioned in the Pros section, you’re IT. You’re the boss, you make the decisions, you handle the load. While this can be a good thing, it also may not be the best thing for a successful business. Each of us has different experiences and challenges in life that create our opinions, values, and views. One lone person doesn’t bring as much to the table.
When you have a corporation or partnership with more people at the helm, there’s a greater pool of experience for solving problems and coming up with unique new ideas. Plus, spreading around the risk and potential headaches can be a good thing. Having others there to help you shoulder the business load can mean the difference between making it and breaking it.
When your business is set up as a corporation, that business lives on, even when you don’t (provided you’ve kept your licensing and tax filings current) If you were to die after having set up a sole proprietorship, the story is a little different. Since the business is essentially YOU, there would be nothing to pass on to the next generation. Anyone who takes over business operations after your death would need to set up a whole new business.
If you want something tangible to pass on to your children or others in the event of your death, or something you can sell and make a profit on when you’re ready to exit, then you’ll want to set your business up as a corporation.
No matter how you decide to structure your business, ZipBooks is here to help! Our suite of accounting and bookkeeping tools will not only help you keep accurate records and stay on top of your billing, but will also give you suggestions on how to run your business better! Even if you set up a sole proprietorship, you won’t be in business alone.
Tim is Founder and CEO of ZipBooks. He keeps his desk really nice and neat.