Your business is, by nature, a one-person show. It’s you and you alone, forging ahead as a single-employee operation. Whether you’re a freelancer, contractor, consultant, or you sell hand-knitted socks at the farmer’s market, you’re already a sole proprietor.
This is the simplest business type available to American entrepreneurs, as sole proprietorships don’t even require that you formally create your business ― the company is considered an extension of its individual owner. However, a sole proprietorship can be a limiting business structure, so it might not be the right choice for everyone.
Even if you’re already operating as a sole proprietorship, it’s a good idea to understand the business structure’s pros and cons, especially in comparison to a limited liability company (LLC). So, read on, fearless entrepreneur! And by the time you’re done, we’re confident that you’ll know whether this is the right business type for you.
IMPORTANT: If you want to protect your personal assets and business, consider forming an LLC. And if you need help starting an LLC or just want to make sure it’s done correctly, hire an online LLC service like 🥇 ZenBusiness ($39) or LegalZoom ($99). They take care of all the legal paperwork so you can focus on what you do best.
What Is a Sole Proprietor?
Unlike most other American business structures ― including corporations, limited liability companies, etc. ― a sole proprietorship is not a legal entity or an incorporated business. In fact, it isn’t even a distinct entity from its owner as an individual and can operate entirely under the owner’s name. It simply turns you as a person into a functioning business.
The main reason sole proprietorships are so popular is the fact that there is no setup process, and there are no fees involved with starting or operating one. Have a business idea? Just start working on it and you’re a sole proprietor! There’s nothing else to it.
A sole proprietorship simplifies your taxes too, as you’ll claim all business profits and losses on your personal return. As the sole proprietor, you can sign contracts using your own name, and customers can make payments by writing a check directly to you. Sole proprietors can also mix their personal and business assets as much as they want, which is not the case for LLC and corporation owners.
What Are the Advantages of a Sole Proprietorship?
We’ve mentioned that a sole proprietorship is easy, but you can’t truly appreciate how easy until you’ve seen everything it offers. Here are the benefits of living life as a sole proprietor:
- No-Hassle Formation and Maintenance: Finding the correct government forms, filling them out, submitting them to the state, waiting to be approved, finding a registered agent, keeping up with annual reports. This is just a short list of the requirements for forming most business types. But as a sole proprietor, you don’t have to worry about any of it. There’s no formation process and no maintenance requirements either. You can dive right in, no startup necessary.
- No Fees: What’s better than no paperwork? No fees. Formal business structures are required to pay startup fees for the forms they file, and they typically have ongoing expenses – like annual reports – as well. As a sole proprietor, you will avoid these fees, keeping more money in your pocket.
- Can Commingle Income: Corporations and LLCs require you to keep your business and personal finances completely separate, both for taxation purposes and in case your business is sued. Because the sole proprietorship isn’t distinct from you as a person, you can commingle business and personal assets as much as you’d like.
What Are the Disadvantages of a Sole Proprietorship?
Before you go getting the idea that a sole proprietorship is too good to be true, we should let you know that it has some significant shortcomings as well, including:
- No Personal Asset Protection: Your business and personal assets are one and the same. This means if you’re sued, a creditor can come after your personal assets, including your house, car, and bank accounts. An LLC or corporation will only allow creditors to pursue your business assets.
- Unattractive to Investors: If you were an investor, would you feel more comfortable putting your money behind an actual business or an individual person? That question may seem a bit silly, but it’s nearly impossible for sole proprietors to raise capital. As a sole proprietor, you’re not allowed to sell shares of your business, and it’s exceedingly rare to see venture capitalists pay attention to sole proprietors.
- Can’t Transfer Ownership: You started this sole proprietorship, and now you’re stuck with it. But seriously, because there’s no distinction between you and your business, you can’t simply transfer ownership to someone else. Instead, if you want to sell your business, you’ll have to sell each asset individually.
What Are the Alternatives to a Sole Proprietorship?
If you think the disadvantages outweigh the advantages, then a sole proprietorship probably isn’t right for your business. Fortunately, you have a couple of other options. You could form a corporation, although the single-member limited liability company (SMLLC) is a much more common choice for one-person businesses.
An SMLLC has relatively low startup costs, while still protecting your personal assets just like a corporation. In addition, you can easily transfer ownership of an SMLLC, and it’s a much more appealing business type to investors than a sole proprietorship. Not only that, but its tax structure is flexible, so you can continue reporting income on your personal returns, or you can elect to have the business taxed separately if you’d like.
Are you interested in learning more about the single-member limited liability company? Take a look at our extensive guide to SMLLCs to find out if it’s a better fit for you than a sole proprietorship.
If you’re looking for simple, look no further, because the sole proprietorship is the simplest business structure out there. Legally speaking, it’s just an extension of you as a person ― you and your business are not distinct entities. The moment you start doing business, you are automatically considered a sole proprietor.
A lot of businesses are more complicated than that, though, with intricate finances, operations, processes, and policies. If you want to make your business more legitimate, or if you have plans for growth, it’s probably a good idea to form a single-member LLC instead. It’s not a particularly expensive business type to form or operate, and it gives you some significant advantages like limiting your personal liability and attracting investors.
But we have no doubt that you’re a shrewd entrepreneur, and you’ll make the right decision for your business, leading it into success regardless of its structure!