Sole Proprietorship Advantages and Disadvantages

Many companies start as sole proprietorships, and some stick with that business structure for their operations. Sole proprietorships are businesses where a single person owns and runs a company with no separate legal existence, such as a corporation or limited liability company (LLC).

Sole proprietorships have many advantages over other types of business structures. The owners have complete control over the entire business, can set up without much formality, and their tax filing and accounting are simple. However, there are some disadvantages as well.

A new business owner should be aware of the potential pros and cons of a sole proprietorship.

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Advantages of a Sole Proprietorship

Ease of Set Up

A sole proprietorship is easy to start up because there are fewer formal requirements. For example, you do not have to file paperwork with the secretary of state to register it as a separate legal entity as you would with a corporation or LLC. The owner can operate under their own name or a trade name for their business. For a trade name, they would apply for a DBA (doing business as) name to use instead of their own name.

Avoiding Double Taxation

Sole proprietors have a simplified tax structure and do not pay corporate taxes on business income. Instead, any profits or losses of the business pass through to the business owner’s personal tax return. This pass-through taxation avoids double taxation where profits are taxed at the corporate level and then the personal level.

However, corporations (that elect S corporation status) and LLCs act as pass-through entities where the profits and losses go on an individual’s income tax return that gives the business owner some legal protection against business liabilities and avoids double taxation.

Fewer State Formalities

If you set up a corporation, you file articles of incorporation. If you set up an LLC, you file articles of organization. As a separate business structure, you must file annual reports and pay franchise taxes to the state. There is less record-keeping as well since you do not have to create bylaws if you had a corporation or an operating agreement if you formed an LLC.

Disadvantages of a Sole Proprietorship

Unlimited Personal Liability

The most significant disadvantage of an owner of a sole proprietorship is that there is no liability protection for your personal assets. This means that if anyone sues the business for any reason, your cash, car, or home is on the line.

This is different from both an LLC (limited liability company) and a corporation, where there is a strict separation between the business assets and the owners’ personal assets. When someone sues an LLC or corporation, the most that person can get is its business assets. This protects the business owners.

Most sole proprietors buy business insurance in case they are sued. While insurance can help by providing money to settle lawsuits, it will not always offer complete protection. Many policies only cover certain kinds of cases, such as personal injury suits if someone slips and falls on your property. Any other claim, like a collection action from one of your vendors, is not covered by insurance. Additionally, the money the policy provides may not be enough to cover your damages, which leaves your opponents free to go after your personal assets.

The Business Dies With Its Owner

Courts do not see any difference between a sole proprietorship and its owner. So when the owner passes away, the business ends unless the owner makes a prudent estate plan that allows the company to continue.

In a corporation, the business is separate from the owner and is said to have a “perpetual existence,” which means that it will continue even if its owners, directors, and shareholders die or leave the company.

More Difficult to Raise Money

Corporations have many ways to raise money to invest in the business. One of the easiest ways for a corporation to raise money is to sell shares. Selling shares gives people a piece of the company in exchange for the money they invest. However, a sole proprietorship has no shareholders and cannot sell shares without changing its business structure.

Sole proprietorships may borrow money just like other business structures. However, because there is no separation between business and personal assets, many sole proprietors need to use their personal assets as collateral for the business loan. A sole proprietor can even use their home as collateral. If the business fails and the owner does not have enough money to pay the loan, the lender can take away the owner’s personal assets to get that money back.

See FindLaw’s small business section to help you decide which legal structure is best for single owner as well as a helpful checklist for setting up a sole proprietorship.

Get Legal Help Setting Up Your Sole Proprietorship

Although sole proprietorships are by far the easiest type of business entity to set up, they also subject the owners to personal liability for business debts. If you have any questions about the legal implications of a sole proprietorship, contact a local small business attorney today.

Related Topics

• Choosing a Legal Structure
• Sole Proprietorships
• Corporations
• LLCs