A sole proprietorship is a business owned and functioned by a solo individual. The proprietor is personally responsible for all debts and compulsions of the business, and the business does not have a separate legal identity from the owner.
Sole proprietorships are the simplest and most common form of business ownership. They are easy to set up and require little paperwork. The owner can keep all of the profits, and there is no need to share ownership or profits with anyone else.
However, there are also some disadvantages to sole proprietorships. The owner is personally responsible for all debts and obligations of the business, which means that if the business fails, the owner could lose their personal assets. Additionally, sole proprietorships do not have the same legal protections as other forms of business ownership, such as corporations or limited liability companies.
Sole Proprietorship Explained
A sole proprietorship is a business entity that isn’t legally separate from its owner. Any individual can start such a business as it is not governed by any statute. It can be thought of as an extension of the owner. Therefore, its continuity is solely dependent on the owner.
Proprietors exercise total control over their businesses and have the freedom and flexibility to operate according to their preferences. This gives them the right to keep all the profits of the business. However, at the same time, they have to incur all losses of the business unconditionally.
Business creditors can hold the owner personally liable in case of unsettled debts. In addition, any public harm caused by the product or any major accident at the business site is the personal responsibility of the proprietor. Thus, any damage to or by the business can bring a bad name to the proprietor or result in legal issues.
How to Set Up a sole Proprietorship?
To start working as a sole proprietorship, individuals can set up the business in their name without any legal paperwork and commence trading. However, if the business is not using the proprietor’s name, the owner must register it with the local authority by filing a “Doing Business As” (DBA) form. DBA ensures that the business has a distinct name assigned and that the nature of the business is known to the authority.
Note that filing a DBA is not mandatory. It depends on the nature of the business and the proprietor’s preference. After filing the DBA, the proprietors can employ staff and rent commercial premises to operate their business. On hiring employees, the proprietorship must apply for an employer identification number (EIN) from the Internal Revenue Service (IRS).
Sole Proprietorship Characteristics
The following are the key characteristics of a sole proprietorship:
Individual ownership – The owner of a sole proprietorship is the whole and soul of the business. From contributing capital to managing its affairs and making decisions, all rests with a single individual.
No distinction between the owner and the business – Since the business is not an isolated legal entity, the owner must bear any profit and loss from business operations.
No independent taxation – There is no separate taxation for the business as it doesn’t have a distinct legal existence. Therefore, proprietors report all business profits and losses on their personal income tax returns. Thus, the owner shoulders all tax obligations. Proprietors only pay the tax on their total income to the IRS without paying any corporate tax.
Unlimited liability – Any loss by the business is a personal loss to the owner. Owners have to assume all debts and liabilities of the business and offset them using their personal income or property.
Limited legal formalities – Sole proprietorship is the most common form of a business structure due to the minimum paperwork required to establish it. Any individual with the requisite capital and necessary license or permit can start a business with almost no government intervention.
No minimum capital investment – There is no set minimum investment to start a proprietorship business. Any individual can commence with available capital. Thus, small businesses usually use this business structure.
Easy commencement and closure – Owners can start or close a proprietary business at their discretion, as its total control rest with them. They need not consult with any other person or government for the same.
Most of the businesses in the US are proprietorship firms. This is because there are numerous advantages of a sole proprietorship:
- Minimal legal paperwork required
- Easy to establish and wind up
- Maximum freedom and privacy in operation
- Simplified banking through business checking accounts
- Considered a pass-through business for taxation
- No separate taxation of the entity; owners report business profits and losses on their personal income tax returns
- No corporate tax charged
A sole proprietorship also has several disadvantages, as discussed below:
- No segregation of the business from the proprietor
- Unlimited liability for the owner
- Difficulty in obtaining credit or finance
- More income taxes for the proprietor in case of high profits from the business
- No unemployment benefits for the owner of the business suffers losses
- Employer identification number (EIN) required from the IRS for hiring employees
- Trouble finding buyers for the business
Sole proprietorships are a simple and inexpensive way to start a business. They offer the owner complete control and the ability to keep all profits. However, sole proprietors are generally responsible for all debts and compulsions of the business, which means that if the business fails, the owner could lose their personal assets.
If you are considering opening a sole proprietorship, it is significant to carefully consider the pros and cons before making a decision. If you are comfortable with the level of liability and you are looking for a simple and inexpensive way to start a business, then a sole proprietorship may be a good option for you.