Sole Proprietorships

A Brief Definition of Sole Proprietorships

A sole proprietorship is owned and run by one individual who receives all profits and has unlimited responsibility for all losses and debts.

Learning Objectives

Define a sole proprietorship

Key Takeaways

Key Points

  • In a sole proprietorship, there is no legal distinction between the individual and the business. Thus, every asset is owned by the proprietor, and they have unlimited liability.
  • Examples include writers and consultants, local restaurants and shops, and home-based businesses.
  • A sole proprietor may use a trade name or business name other than his or her legal name.

Key Terms

  • Sole Proprietorship: a business that is wholly owned by a single person, who has unlimited liability

A sole proprietorship, also known as the sole trader or simply a proprietorship, is a type of business entity that is owned and run by one individual and in which there is no legal distinction between the owner and the business. Some formal definitions of a sole proprietorship are “a business owned by one person who is entitled to all of its profits ” (Glos & Baker) and “a business owned and controlled by one man even though he may have many other persons working for him” (Reed & Conover).

The individual entrepreneur owns the business and is fully responsible for all its debts and legal liabilities. The owner receives all profits (subject to taxation specific to the business) and has unlimited responsibility for all losses and debts. Every asset of the business is owned by the proprietor, and all debts of the business are the proprietor’s. This means that the owner has no less liability than if they were acting as an individual instead of as a business. It is a “sole” proprietorship in contrast with partnerships. More than 75% of all United States businesses are sole proprietorships. Examples include writers and consultants, local restaurants and shops, and home-based businesses.

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Mom and pop store: This is a small proprietor with a small shop.

A sole proprietor may use a trade name or business name other than his or her legal name. In many jurisdictions, there are rules to enable the true owner of a business name to be ascertained. In the United States, there is generally a requirement to file a doing business as statement with the local authorities. In the United Kingdom, the proprietor’s name must be displayed on business stationery, in business emails, and at business premises, and there are other requirements.

Advantages of Sole Proprietorships

The advantages of a sole proprietorship versus other forms of organizations is the relative ease of set-up and the lower start-up costs.

Learning Objectives

Discuss the advantages of running a sole proprietorship

Key Takeaways

Key Points

  • Filing taxes as a sole proprietorship is relatively easier than that of a corporation.
  • Sole proprietorships typically require less capital to set up and have easier payroll requirements.
  • Sole proprietorships are not as heavily regulated as other forms of organizations.

Key Terms

  • corporate: An incorporated entity is a separate legal entity that has been incorporated through a legislative or registration process established through legislation.

Advantages of Sole Proprietorship

The sole proprietor form of business ownership is the most common form in the United States and also the simplest. In this form of business ownership, an individual proprietor owns the business, manages the business, and is responsible for all of the business’ transactions and financial liabilities. This means that any debts incurred must be paid by the owner. This form of business has several advantages.

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A Writer’s Office: A writer enjoying the advantages of being a sole proprietor.

Quicker Tax Preparation

As a sole proprietor, filing your taxes is generally easier than a corporation. Simply file an individual income tax return (IRS Form 1040), including your business losses and profits. Your individual and business income are considered the same and self-employed tax implications will apply.

Lower Start-up Costs

Limited capital is a reality for many start-ups and small businesses. The costs of setting up and operating a corporation involves higher set-up fees and special forms. It’s also not uncommon for a lawyer to be involved in forming a corporation.

Ease of Money Handling

Handling money for the business is easier than other legal business structures. No payroll set-up is required to pay yourself. To make it even easier, set up a separate bank account to keep your business funds separate and avoid co-mingling personal and business activities.

Government Regulation

Sole proprietorships also have the least government rules and regulations affecting it. They do need to comply with licensing requirements within the states in which they do business and they do need to pay attention to local regulations. However, the paperwork required is much less than large corporations. Thus, they can operate quite easily. Sole proprietorships also do not pay corporate taxes.

Sale and Inheritance

The sole proprietor can own the business for as long as he or she decides, and can cash in and sell the business when they decide to get out. The sole proprietor can even pass the business down to their heir, a common practice.

Disadvantages of Sole Proprietorships

Sole proprietorships face a number of difficulties in the longer terms compared to limited liability companies.

Learning Objectives

List the disadvantages of sole proprietorships

Key Takeaways

Key Points

  • The owner of a sole proprietorship is solely liable for all debts and actions of the company. All personal wealth is linked to the business.
  • Financial statements are not required in a sole proprietorship as are typically required of a corporation, meaning a lack of financial control is very probable.
  • It is difficult to find outside investors to fund sole proprietorships, meaning growth potential is very limited beyond a certain point.

Key Terms

  • unlimited liability: The liability of an owner of a small proprietorship for all costs and debts of the business.

Sole proprietorships are the smallest form of business organization, and also the most common in the United States. However, while there are certain advantages (it is easier to set up a sole proprietorship than a limited liability company, for instance), there are a number of big disadvantages, particularly in the long term, that make the sole proprietorship model quite unattractive to business owners.

The main disadvantages to being a sole proprietorship are:

Unlimited liability: Your small business, in the form of a sole proprietorship, is personally liable for all debts and actions of the company. Unlike a corporation or an LLC, your business doesn’t exist as a separate legal entity. Therefore, all of your personal wealth and assets are linked to the business. For instance, if you go bankrupt and owe your debtors $100,000, then that money will have to come out of your own wallet even if there is no money left in the business. If you operate in a higher risk business, such as manufacturing or consumables, the cost to benefit ratio is favorable toward a corporate structure.

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Sole proprietorships have unlimited liability: A sole proprietor will be responsible for all the costs and debts of their company.

Lack of financial controls: The looser structure of a proprietorship won’t require financial statements and maintaining company minutes as a corporation. The lack of accounting controls can result in the owner being lax about financial matters, perhaps falling behind in payments or not getting paid on time. It can be a serious issue if financial controls are not strictly managed.

Difficulty in raising capital: Imagine your business in five years. Will it still be a business of one? Growing your small business will require cash to take advantage of new markets and more opportunities. An unrelated investor has less peace of mind concerning the use and security of his or her investment, and the investment is more difficult to formalize; other types of business entities have more documentation. Outside investors will take your company more serious if you are a corporation.