Are you getting ready to start your own business? If you're going to be the sole owner of your business, you'll need to decide if you're going to operate as a sole proprietor or if it would be better for you to form an official business entity. Discover some key advantages of sole proprietorships, as well as important drawbacks associated with this type of enterprise. Armed with this information, you'll be better prepared to move forward with your plans to become a solopreneur.
Key Sole Proprietorship Advantages
Sole proprietors are self-employed solopreneurs who engage in business without establishing a separate legal entity. Depending on the type of work you plan to do and your personal financial situation, working as a sole proprietor may be the ideal option for you. There are definitely some advantages to consider.
- Less paperwork - A sole proprietorship doesn't require an articles of organization or articles of incorporation document like you'd need if you decided to start a limited liability company (LLC) or corporation.
- Low startup costs - Depending on your business type and location, you may still need a business license and/or permit to operate as a sole proprietor. However, you won't have to pay the state filing fees associated with forming a legal business entity.
- Faster startup - Since there are fewer documents to draw up and file with a sole proprietorship than other types of organizations, that means that it can be faster to launch a sole proprietorship than going another route.
- Simple taxation - No separate business tax filings are required for a sole proprietorship. Instead, as a sole proprietor, you'll simply pay personal income tax on the profits from your business endeavor.
- No UC tax filings - As a sole proprietor, your earnings will come from the profits of the business rather than wages or salary. As a result, you won't have to pay unemployment compensation (UC) tax on yourself. (Note: If you hire employees, you will have to pay UC for them).
- Simplified banking - Sole proprietors don't have to open a separate checking account for their business. Some do so, but it is not a requirement. As a sole proprietor, you can choose the banking option that works best for you.
- Complete autonomy - Sole proprietors are independent entrepreneurs with autonomy over their business ventures. You still have to abide by laws and regulations, but you don't have to have officers or board members.
Important Sole Proprietorship Disadvantages
The advantages of sole proprietorship listed above may sound great to you, but they are not the only factors you need to consider when going into business for yourself. Be sure to carefully consider the advantages and disadvantages of a sole proprietorship before moving forward.
- Unlimited personal liability - As a sole proprietor, you have unlimited personal liability for the business. There is no separation between you and the business, so your personal assets are fair game to business creditors.
- No separate business name - Since a sole proprietorship isn't a legal entity, then the owner's name is the name of the business. If you don't want to trade under your name, you'll need to establish a fictitious business name. Your business name would be your name, followed by dba (which stands for "doing business as"), then the fictitious name. Depending on your state, you may need to reserve or register your dba identity with the Secretary of State.
- No access to business credit - Since a sole proprietorship isn't a separate business entity, you won't be able to build credit or secure loans specifically for the business. You'll need to use personal loans or credit cards for any business funding needs. (Note: Even if you could take out a business loan, you'd still be on the hook for it personally due to the unlimited liability associated with this type of enterprise).
- Self-employment tax filings - As a sole proprietor, you'll need to file quarterly income tax payments throughout the year. This includes federal and state (if applicable) income tax, as well as Federal Insurance Contributions Act (FICA) payments.
- No access to UC - As a sole proprietor, you are not an employee of your company. That means that you will not be eligible for unemployment compensation (UC) from the state if your business closes or experiences an interruption.
- Must maintain solo ownership - Sole proprietorships have to have only one owner. If you want to take on a business partner, you will have to change to another type of business, such as a partnership, LLC, or corporation.
- Complicated transfer of ownership - Since your business isn't a legal entity, it's not possible to directly sell or otherwise transfer ownership to another person. There is a way around this; what you'd need to do is sell or transfer the assets of the business to another person rather than the business itself.
Is Sole Proprietorship Right for You?
You'll need to consider the nature of your business and your personal financial situation when choosing how to structure your business. If, for example, you are a freelance writer or consultant who will offer services that don't require significant business expenses or have a high level of inherent risk, sole proprietorship could be a great option. However, that doesn't mean that all consultants should go this route. If the type of consulting you do is one for which liability is an important concern, then it would probably be in your best interest to launch an LLC or to incorporate your business. It's best to consult with an attorney who specializes in small business formation before making such an important decision.