What is a Sole Proprietor?
Are you self-employed, or otherwise operating a one-person business? If so, you’re already a sole proprietor.
This is the simplest business type available to American entrepreneurs, as sole proprietorships don’t even require you to formally create your business ― a sole proprietor is considered to be an extension of its owner as a person. However, a sole proprietorship can be a limiting business structure, so it might not be the right choice for everyone.
In this guide, we’ll discuss the pros and cons of being a sole proprietor, specifically in comparison to operating a limited liability company. By the time you’re done reading, we’re confident that you’ll know whether this is the right business type for you.
What Is a Sole Proprietor?
Unlike most other American business structures ― like corporations, limited liability companies, etc. ― a sole proprietorship is not a legal entity or an incorporated business. In fact, a sole proprietor isn’t even a distinct entity from its owner as an individual, and it can be operated under the owner’s name.
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. All you need to do to become a sole proprietor is merely start working!
With a sole proprietorship, there’s no need to file a business tax return, as any profits or losses are claimed on your personal return. As the sole proprietor, you can sign contracts using your own name, and customers can pay you by writing a check in your name too. Sole proprietors can also mix their personal and business assets as much as they want.
What Are the Advantages of a Sole Proprietorship?
While we’ve briefly touched on these attributes in the previous section, let’s run them down in detail, shall we? There are some distinct advantages to being a sole proprietor, which include…
- No-Hassle Formation and Maintenance: Most other business types require you to draft and file formation documents with your state government, which can be a real hassle. You’re also usually required to designate a registered agent to receive and forward your important government documents, and you also need to file annual reports. As a sole proprietor, you don’t have to worry about any of this. There’s no formation process, and no maintenance requirements either.
- No Fees: Continuing from the previous point, formal business structures are required to pay startup fees, and also typically have ongoing expenses as well. As a sole proprietor, you will avoid these fees, keeping more money in your pocket.
- Can Commingle Income: With a corporation or an LLC, you’re required to keep your business and personal bank accounts strictly separated, both for taxation purposes, and also 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 all you want.
What Are the Disadvantages of a Sole Proprietorship?
Although there are some clear-cut advantages to running a sole proprietorship, this business structure has some serious disadvantages too. As a sole proprietor, you’ll need to deal with the following shortcomings…
- No Personal Asset Protection: LLCs and corporations limit your personal liability, but sole proprietorships do not. If you’re sued as a sole proprietor, a creditor can come after your personal assets, including your house, car, and bank accounts. With an LLC or a corporation, creditors are only allowed to pursue your business assets.
- Unattractive to Investors: If you were an investor, would you want to put your money behind an actual business, or an individual person? While that question may seem a bit silly, 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 any attention to sole proprietors.
- Can’t Transfer Ownership: Because a sole proprietor has no distinction between him/herself and their business, you cannot simply sell or transfer your business to someone else. Instead, if you want to transfer ownership of your business, you’ll need to sell your business assets individually rather than selling it off as a whole.
What Are the Alternatives to a Sole Proprietorship?
If you would rather form a formal business structure than operate a sole proprietorship, you have a couple options. You could form a corporation, although the single-member limited liability company (SMLLC) is a much more common choice for one-person businesses for a variety of reasons.
An SMLLC has relatively low startup costs, while still protecting your personal assets just like a corporation does. In addition, you can easily transfer ownership of an SMLLC, and it’s a much more appealing business type to investors, compared to a sole proprietorship.
Are you interested in learning more about the single-member limited liability company? We invite you to take a look at our extensive guide to SMLLCs to find out if it’s a better fit for you than a sole proprietorship.
There’s really not much to a sole proprietorship, because legally speaking it is just an extension of the owner as a person ― you and your business are not distinct entities. The moment you start doing business, you are automatically considered to be a sole proprietor.
If you want more formality to your business, or if you have plans for growth, it’s probably a good idea to form a single-member LLC instead of continuing as a sole proprietor. It’s not a prohibitively expensive business type to form or operate, and it gives you some significant advantages like limiting your personal liability and attracting investors.
Whether you choose to operate your business as a sole proprietorship, or if you’d rather power up your business with a formal structure, we wish you the best of luck!
Quick Note: If you need help forming an LLC, IncFile and LegalZoom are popular services that can take care of the paperwork for you.