Planning a new venture is awesome!
As a new business owner, an individual must be equipped with all the critical information about sole proprietorships – like what sole proprietorship is and the advantages and disadvantages.
But finding the critical information explained simply and clearly might be a hassle. So, we have created this blog stuffed with all the necessary details about the sole proprietorship business.
Let’s begin exploring!
What is a Sole Proprietorship?
A sole proprietorship is a business structure that a single individual owns. It is one person who takes all the business responsibilities and makes decisions.
The best thing about a sole proprietorship is that there’s nothing complicated about it. It is the simplest business structure where the business is not considered a separate legal entity. Also, the owners do not require federal registration to run the business.
The Top Advantages of a Sole Proprietorship Business
The advantages of a sole proprietorship are many. Here’s a list of the most relevant benefits of a sole proprietorship.
1. Easy to set up
The simplest business structure and an inexpensive one, sole proprietorships do not require formal registration.
Sole proprietors need not notify the business registration at state or federal offices. Hence, the only cost involved is registering the business name, and getting the apt permits or licenses.
2. Lesser paperwork
Business setup involves several tasks. Among these, one of the most dreaded ones is paperwork or documentation.
Most of the ‘would-be’ business owners do not wish to spend their time in the lengthy process of registering the business as a corporation. So, for such individuals, a sole proprietorship is the best option.
The paperwork in a sole proprietorship is much less. Hence, business owners can spend their time planning the business strategies to prevent risks in the long-term journey.
3. Simple tax calculations
One of the benefits of being a sole proprietor is that the taxes are simpler. The tax requirements are pretty straightforward compared to the other business structures.
Unlike other business types, sole proprietors are not required to file for an EIN. Plus, they have the option to use their Social Security number to pay employees.
Sole proprietorships are not considered separate legal entities. So, business income or losses are reported on the owner’s income tax. The sole proprietors need not file taxes separately for personal and business transactions.
Besides these, sole proprietors also get certain tax advantages accompanying small business deductions.
4. Flexibility and liberty
One of the most sought-after advantages of a sole proprietorship is the flexibility and freedom that the owners get.
As a sole proprietor, the owner is free to make the choices for the business. The decision-making is entirely in the hands of the sole proprietor.
Plus, sole proprietorships are not restricted to strict trade regulations or other complications. Sole proprietors can, thus, save the labor spent on complying with the trading regulations.
So, the degree of flexibility in operations is more in sole proprietorships.
5. Lower business fees
Starting a new venture with a tight budget is not uncommon. Several individuals plan their ventures with less capital. For such entrepreneurs, the sole proprietorship is the best business structure.
Sole proprietorships can help the owners save on registration. Unlike LLCs, a sole proprietorship does not require an annual fee to maintain the registration. So, overall, the legal requirements and involved costs in a sole proprietorship are much less.
A sole proprietorship is, therefore, very affordable. If the venture is well-planned from the start, with 100 percent commitment, one can easily set up a sole proprietorship business.
6. Simple ownership rights
Owning the business is pretty simple in a sole proprietorship. There are no additional elements involved, like registration agents or company officers.
The decision-making, finances, and everything else are wholly owned b the sole proprietor. It is the single business owner who decides how the venture will function.
This being said, there are no concerns involving boards, officers, or other positions in typical business structures that include giving away part ownership and control rights.
Moreover, sole proprietorships are not formally registered. So, a degree of autonomy and privacy is maintained. The owners are free to control their business and operate as they wish to.
7. Easy and simple banking aspects
An advantage of a sole proprietorship is that it involves straightforward banking.
Like taxes, a complicated banking process creates hassles. The banking in this business structure is simple, and this is one of the best pros of a sole proprietorship.
The personal account of the owner can be the business account. However, during taxation, it might take time to separate expenses. So, it is advisable to have a separate business account.
Pretty straightforward, right?
8. No limit on hiring staff
In a sole proprietorship, owners can hire as many staff as required. This will allow the business to grow, reach more people, and have a growing team.
However, it is always necessary to keep a watch on the business budget while hiring employees.
What are the Disadvantages of a Sole Proprietorship?
We cannot say that there are only advantages of a sole proprietorship. There are several disadvantages of a sole proprietorship as well.
To run the business effectively, one must know both sole proprietorship’s pros and cons. So, let’s see the list of disadvantages of a sole proprietorship business!
1. Unlimited liability
The most significant disadvantage of the sole proprietorship is no protection from liability. Every business liability is a personal liability since there is no legal entity concept.
So, while the owners have the freedom to control and make decisions independently, they are also solely liable for the business. This liability spans the company and the owner’s assets.
In other words, if the owner cannot clear debts, creditors can access their personal property, savings, cars, etc., for debt repayment.
As a sole proprietor, one might take a personal loan, sign a personal guarantee, and put out personal assets as collateral. So, if there is a loan default, the bank can seize the owner’s assets. Hence, appropriate insurance is a must as a precaution.
2. Difficulty in raising capital
A significant disadvantage of owning a sole proprietorship is the challenge of raising capital.
Though the setup costs are much lower in a sole proprietorship, it is difficult to finance the business. But why?
Because banks mostly prefer to finance established businesses. Also, since the revenue in such companies is more significant, they are considered to have a strong credit history.
In a sole proprietorship, the business is wholly reliant on a single owner’s finances, investments, and credit history. So, banks and other lenders are often doubtful about the repayment aspect.
3. Selling the business is a challenge
Generally, entrepreneurs do not want to consider the possibility of selling their businesses. But as the owner, it is practical to contemplate passing the baton.
Selling a sole proprietorship business is challenging, and there are reasons behind it. If the business is significantly profitable, selling it would trigger high capital gains tax.
This tax is imposed on the gains of the business from the start till the date of sale. It can run up to a whopping 49% of the total gains.
Also, selling off a sole proprietorship business means selling the debts. New start-ups might have more debts than profits. This often makes it difficult to predict profits for potential buyers.
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4. Less financial control
In a sole proprietorship business, financial reports are not mandatory as a part of business operations.
Moreover, a single person is responsible for making final marketing, accounts, strategies, etc.
Sole proprietors are often overwhelmed with so many responsibilities and hence, they sometimes let go of a few business transactions. This can further be the reason behind a significant lack of financial control. Also, it may give rise to several risks in business.
Keeping track of the business costs – overhead expenses, labor charges, utilities, etc. often becomes challenging. And this might impact the overall income, profits, and losses of the business. As a result, taxation will be difficult as well.
5. Limited management skills
A sole proprietor is responsible for making decisions single-handedly. So, the limited management skills of the owner are one disadvantage of a sole proprietorship.
The sole proprietor might not have all the skills to manage the business efficiently. Though hiring professionals is possible, budget constraints might still be a problem.
Overall, this disadvantage tends to create difficulties in the growth of the business.
6. Risk in decision-making
One of the significant disadvantages of a sole proprietorship that several people do not consider is the risk of making wrong decisions.
As we have already mentioned, the final decision of every business function depends on the owner.
In a sole proprietorship business, there is nobody to assist in decision-making.
So, the risk of errors in decisions is high in sole proprietorships.
7. No economies of scale
Large-scale business organizations enjoy large-scale economies as well. That means they can produce more in lesser overhead costs per product.
But for sole proprietorships, this is hard to achieve.
Hence, the cost of production of sole proprietorships is generally high. So, facing competition from larger organizations becomes quite challenging for sole proprietorship businesses.
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What are 5 advantages of a sole proprietorship?
- Easy to set up
- Minimal paperwork
- Flexibility and Liberty
- Simple ownership rights
- Straightforward banking tasks
What are 3 disadvantages of a sole proprietorship?
- Responsibility for raising capital
- Unlimited ownership of any liabilities
- Sole decision-making responsibility