Pros & Cons of Starting a Business as a Sole Proprietorship

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Starting a Business as a Sole Proprietorship

Starting a sole proprietorship is popular among small brick-and-mortar, service-based, and online businesses.

This article will go over the pros and cons of starting a business as a sole proprietorship.

Even though a sole proprietorship is easy to start, it’s one of the most popular types of structures for new startups. It’s necessary to note that different countries and jurisdictions have different laws. Therefore, it’s essential to consult with a professional to identify the laws and tax requirements for a sole proprietorship in your area. It’s a good idea to get accurate information before starting.

A competent lawyer, CPA, or bookkeeper can give you the advice you need to get started on the right track for your business idea.

The Pros and Cons of Starting a Sole Proprietorship:

Next, let’s go over some of the pros and cons of starting a business as a sole proprietorship.

The Pros of Starting a Business as a Sole Proprietorship:

Easy To Start:

An open sign in a doorBecoming a sole proprietor is as easy as opening your doors for business. No registration is necessary for starting this type of entity. You don’t need to focus on structuring your business. You only need to focus on running it.

It’s important to note even though you don’t have to register, you still may need a business license depending on the type of business you’re starting. Contact your local municipality to determine if a business license is required for your startup.

As a sole proprietor, you and the business are one entity from a legal and tax perspective. You would be operating under your personal name as the business name. 

If you would rather operate your business under a different name, you could apply for a DBA which means, “Doing Business As.” With a DBA, you can still have a sole proprietorship and a business name other than your personal name. You would have to make sure the name is available for registration.

You Can Start Your Business as a Trial Run:

Because a sole proprietorship is so easy to start, it allows you to try out a business idea without investing a lot of money in the startup process. Naturally, you may have a business idea that requires a lot of startup cash. You wouldn’t be saving a lot in that case, and it might be better to register as an LLC or a corporation.

You Can Change Your Business Structure:

You can always start as a sole proprietorship, and when your business starts to gain traction, you can switch it from a sole proprietorship to an LLC or a corporation.

Many successful businesses started off as sole proprietorships, which include:

  • eBay
  • Kinko’s
  • J.C. Penney
  • Walmart
  • Marriott Hotels
  • Sears
  • A&W

So as you can see from the list above, many businesses start off as a sole proprietorship and incorporate when needed.

Easy To Walk Away:

Another advantage of starting a business as a sole proprietorship is that it’s easy to walk away if it doesn’t work out. As long as you take care of any debt you acquired, you can consider the business closed. 

Complete Control:

A woman working in a shopAs a sole proprietorship, you are in control of the business. You make the decisions. In contrast, to running a business with partners. Decisions will need approval from partners. Even if you have controlling voting shares, good business practices require you to discuss it with your partners. 

The Cons of Starting a Business as a Sole Proprietorship:

No Asset Protection:

As a sole proprietorship, you and the business are one entity; therefore, you are liable for all debt. For example, you are in so much debt, and you have to declare bankruptcy. You could end up losing your personal assets. This is because you and the business are considered one entity. You could lose your house, cars, and everything you own.

If you are subjected to a commercial lawsuit, your personal assets are at risk. This is because the law recognizes you and the business as one. Therefore everything you own could be lost if you lose the lawsuit.

A lawsuit against an LLC or a corporation can only go after the assets of the LLC or corporation, not your personal assets because you and the business are separate.  

Hard To Get Funding:

A sole proprietorship is associated with being a small startup. However, it’s difficult to get funding from a financial institution because of the risk involved.

Many financial institutions don’t see a sole proprietorship as a strong, established business. Instead, it’s seen as a business still finding its way that can close at any time. As a sole proprietorship, your business is viewed as a high risk.

You would have to get funding as a personal loan. So, for example, if a bank sees the loan to be a high risk even though it’s a personal loan, you still won’t be able to get funding. 

Banks are interested in making loans. That’s how they make their money, but they’re not interested in high-risk funding. The bank is not interested in foreclosing on your house. They’re interested in successful businesses. So they can make money from interest on the money you borrow.

No Partners Allowed:

As a sole proprietorship, there must be only one owner. You can’t have a partner as a sole proprietorship. You will have to create a different business structure if you plan to have one or more business partners.

You Can’t Have Investors:

As a sole proprietorship, you can’t attract investors. Because investors would need to have a contract, and if they’re looking for shares in the business, you need to register a different business structure, such as a corporation, to allow shares.

Sole Proprietorship Tax Implications:

People doing billingThe IRS recognizes you and the business as one entity. Therefore, all profits from the business are taxed as your personal income. 

For example, if you have a job and run a sole proprietorship, you’re taxed on your income from your job and the profit you make from the business. 

Your bookkeeper or accountant can fill in the appropriate tax forms when you’re running a sole proprietorship. In the US, it’s called a schedule C. Depending on where you’re operating, your business tax laws may differ.

When Should Switch From a Sole Proprietorship to Another Entity?

Attracting Investors:

If it’s time to attract investors to increase funding, it’s time to switch from a sole proprietorship to an LLC or corporation. An investor can’t invest in a sole proprietorship because it can only be owned by one person.

Looking For Partners

Whether you’re considering a partner for a strategic alliance or to attract funds, you’ll need to change your business structure. As mentioned above, sole proprietorships can only have one legal owner. When partnerships are in the future, then it’s time to make the switch. 

Increase in Risk:

If you’re starting to see some traction in your business and dealing with products and services that are susceptible to a lawsuit, it’s a sign to become an LLC or a corporation to protect your personal assets. 

Starting To Make a Sustainable Profit:

a man working in a woodworking shopWhen you start making a decent profit. Then it’s time to switch because of the tax benefits. Your account or CPA will tell you when it’s time.

You could be making $40,000 and still be okay. But if you’re making $40,000 while having a full-time job, then you’ll want to convert your sole proprietorship to a different entity.

Your best bet is to consult with a professional once you start making a profit so that you know exactly when it’s time to make the switch. 

Conclusion:

Well, there you have it. You now have an overview of starting a business as a sole proprietorship.

I strongly recommend you consult with a knowledgeable CPA so that they can advise you on the best route to take for your business.