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What Are the Advantages and Disadvantages of a Sole Proprietorship?

What Is a Sole Proprietorship?

A Sole Proprietorship is the default business entity for people who operate a one-person business. No documents are necessary to form a sole proprietorship, they’re automatically created when you start a business.

 

What Are the Advantages of a Sole Proprietorship?

The largest advantage of a sole proprietorship is simplicity. If you don’t make any other arrangements for your business’s structure, you become a sole proprietor the moment you start doing business, whether you’re offering goods or services. If you don’t set up a retirement plan or hire employees, you won’t even be required to apply for an Employee Identification Number (EIN) from the IRS; you’ll report your business’s income on your personal tax return, using your social security number. As a Sole Proprietorship, you retain full control over the company and can make decisions as you see fit, with no partners or shareholders in the way. Another important aspect of Sole Proprietorships is that you don’t have to pay corporate taxes and can shut the business down at a moment’s notice. This liquidity also allows for a business to be sold easily, with little in the way of formalities.

 

What Are the Disadvantages of a Sole Proprietorship?

In a Sole Proprietorship, there is no distinction between you and your business for legal or tax purposes. While this is an advantage in some ways, it can be a disadvantage in others. The primary drawback is the fact that you are personally liable for business obligations. You will be required to pay out of your own pocket for any debts incurred by your business. In the event your business can’t cover its debts, your personal assets may be seized to cover the shortfall. This also applies to any bad calls made by your employees.

 

This potentially volatile nature of Sole Proprietorship will also limit your possibilities for finding an investor willing to put money into your business. The link between you and your business makes such investments too risky. This is not a consideration for most small businesses, but if your business grows quickly, a Sole Proprietorship may limit your opportunities.

 

Many small business owners choose to form an LLC or an S-Corporation instead of a Sole Proprietorship, because these forms provide liability protection. Learn more about forming an LLC or an S-Corporation.