Starting a sole proprietorship is quick and easy. Think of an idea for a business in the morning and it can be a business by the end of the day. However, like any other type of business, not much else is easy about a sole proprietorship. Although they make sense for a lot of consulting, contracting and freelance enterprises, there are plenty of disadvantages to them. Read on to find out about the advantages and disadvantages of a sole proprietorship.
The Advantages Of A Sole Proprietorship
- They're Easy To Form. Starting a sole proprietorship requires very little paperwork. In most cases, you file with your state's corporation commission which very often informs the city or county where you plan to set up shop. And the city sells you a business license. Sometimes it works the other way around and you register with a city business office which then informs the state. Either way, there's not much more to it than that.
- You've Got The Power. As a sole proprietor, you decide how the business operates and who does what. You don't have to consult with a board and you don't have to meet federal or state standards regarding organizational structure or shareholders.
- There's A Lot Of Flexibility. The fact that you have control allows you to respond more quickly to whatever comes your way.
- You Control The Purse Strings. You can decide whether to reinvest the profits or keep them, enjoying all of the business' earnings.
- There's Practically No Bureaucracy. Sole proprietorships must deal with the city or county government where they are located, but there are very few regulations that apply to them.
- It's Easy To File Taxes. Most sole proprietors simply use a Schedule C form to add the profit or loss from the business to the other income listed on their personal tax returns. There is no balance sheet to prepare and no separate business taxes though many states charge business license taxes.
- Tax Rates Are Low. Sole proprietorships can use business losses to offset personal income from a spouse's salary or other sources. That helps explain why sole proprietorships pay taxes at the lowest average effective tax rate, 13.3 percent, according to the U.S. Small Business Administration. That compares favorably with small business partnerships (23.6 percent) and S Corporations (26.9 percent).
- They Can Use Nontraditional Forms Of Financing. Sole proprietorships have access to financing that corporations don't enjoy such as loans from friends and family members and equipment donations from larger businesses and organizations.
- They Are Easy To End. Sole proprietorships are easy to start and they're easy to end. When the time comes, a business can be easily dissolved, sometimes by merely filing a form with the business office in the city or county where the business is located.
The Disadvantages Of A Sole Proprietorship
As you can see, there are quite a few advantages to sole proprietorships. But there are several significant disadvantages as well.
- There Is Unlimited Liability. Sole proprietors are considered risky ventures because sole proprietors are responsible for all business debts and obligations and they are vulnerable to lawsuits. If they are sued, they risk losing all of the business' assets as well as their personal assets which include houses, cars and savings and investment accounts among others.
- They Can Be Fragile. The business can go away if the owner dies or can no longer work for whatever reason. A fledgling sole proprietorship can be crippled if the owner has to serve jury duty for several weeks or months.
- It Can Be Difficult Coming Up With Money. Sole proprietors typically have fewer assets and so they find it more difficult to raise money for expansion and growth. Because they find it difficult to attract investors, they also have a difficult time convincing banks to lend them money. Many sole proprietors rely on their personal savings or on personal loans from family members and friends, according to the Small Business Administration.
- They Lose Out On Others' Expertise. As we said above, sole proprietors get to make all the decisions and they get to do things their way, but that can present difficulties. The sole proprietor is responsible for all decisions, even in areas in which he is unfamiliar. No one can know everything so this lack of expertise within an area can lead to bad decisions. That puts pressure on him to recognize his weaknesses and get help when he needs it, but many don't do that.
- Taxes. There certainly are tax advantages to a sole proprietorship, but the sole proprietor pays federal taxes on the business' total profits, even when some or all of that profit is put back into the business. On the flip side, the owner of an incorporated business pays federal taxes on profits generated from business dividends, his salary and bonuses while the business pays separate corporate taxes on its retained business profit.
- They Look Less Professional. Appearance can be important whether we like it or not, and sole proprietorships look less professional than a partnership or a corporation. This can cost the sole proprietor business that he is perfectly able to do and do well.
If you are thinking about starting a sole proprietorship, take these pros and cons into consideration before making a final decision. Doing your homework ahead of time will help you to make the best decision for your business venture.