Business Startups: Sole Proprietorship

By on August 8, 2018
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Choosing your legal business structure is one of the most important decisions you will make as a new business owner. You should choose a structure that benefits you most in terms of taxes and liability and what fits your current financial situation. As part of FSN’s series on Business Start Ups, here is a look at sole proprietorships. Sole proprietorships are attractive to independent contractors and small business owners looking for quick and easy entry into the business world.

What is Sole Proprietorship?

A sole proprietorship is a type of legal business structure that consists of one owner referred to as a sole proprietor. It is the simplest form of business structure to set up and has the least amount of government scrutiny and legal requirements.

When you create a sole proprietorship, no separate legal entity is created like when you create a corporation or partnership. The owner typically conducts business under his or her own name, eliminating many of the requirements and paperwork required for other business structures. However, this also means that the owner is not protected from liabilities incurred by the company and is personally responsible for all business debts.

Advantages

Getting started is easy!

All it takes to start doing business as a sole proprietor are the licenses and permits required by your city and state. If you are thinking of starting a business as a sole proprietor, check with your local government to see if any permits are required. Also check with the Secretary of State’s office to see if licensing is required at the state level. State requirements vary, so be sure you do your research before doing business. You can usually find this information online but it may take several weeks to obtain the appropriate licenses or permits. Be sure to plan accordingly.

It’s inexpensive to form a sole proprietorship.

The cost of forming a sole proprietorship is minimal. The only costs incurred are for required licenses and permits, and liability insurance if you so choose. If there is risk of potential lawsuits, you may want to consider liability insurance. Managing the business, however, costs nothing since no functional experts are required.

You have sole responsibility.

As a sole proprietor, you are responsible for everything to do with your business. You get to keep all profits, but you also assume all debts and liability. The success or failure of your business is in your hands alone. You must be a motivated entrepreneur to succeed!

It’s easy to maintain privacy.

Sole proprietors do not have to publish their accounts. Their business finances are intertwined with their personal finances and are thus kept private. This is advantageous because competitors are not privy to your business practices.

Sole proprietorships are flexible.

Sole proprietorships typically start off small. It’s easy to grow and change the way you run your business as business needs change. And, because there is only one decision maker, decisions can be made and adapted quickly.

It’s easy to dissolve the business.

Dissolving your business is just as easy as forming it. You can decide to stop doing business any time you like. There is no paperwork to file with the government; you simply stop doing business.

Disadvantages

Sole proprietorships are indeed attractive, especially to small business owners with limited startup budgets. However, there are limitations and drawbacks that should be considered carefully.

Limited Resources

Sole proprietors, more often than not, finance their businesses out of their personal accounts and they are usually operating with a limited budget. A sole proprietor must be careful not to overspend or get into an undesirable financial situation that negatively affects their personal life. It’s best to keep track of business expenses separately even though they are not legally separate from your personal finances.

Limited Managerial Capability

It’s as the saying goes, “jack of all trades, master of none.” You cannot be an expert in all areas of your business; you have to do the best with what you’ve got. The growth of your business can be limited without expertise in a certain area. If you are operating within a limited budget, you may have to get creative as to how you obtain information. If you cannot afford an accountant, look for small business software that will help you keep track of your finances easily. If you cannot afford a web or graphic designer, seek out a student who may be looking for side work, or peruse some of the numerous WYSIWYG sites available.

No Liability Protection

Sole proprietors do not have liability protection. This means, the owner is personally responsible for all actions and debts of the business. When the business fails, the private assets of the owner are utilized to pay off debts. If the business is sued, the owner is personally responsible for legal costs and any monies owed. It’s a good idea to obtain liability insurance to be safe. It’s relatively inexpensive and gives you piece of mind.

Forming a Sole Proprietorship

Other than obtaining the necessary licenses and permits, no formal action is required to form a sole proprietorship. In fact, you may already be a sole proprietor based on your business activities. For example, if you are a freelance writer, you are a sole proprietor.

If you choose to operate under a name different than your own, you will most likely have to file a fictitious name, also known a DBA (“doing business as”). You must choose an original name; it cannot already be claimed by another business. The Secretary of State’s websites usually have a database you can search to ensure your desired name is not already in use.

Taxes

In a sole proprietorship, business and personal finances are the same, therefore, taxes are quite simple. Any income earned by the business is earned income for the owner. Income and/or losses and expenses are reported by filing a Schedule C, along with the standard Form 1040. Profits and losses are first recorded on a tax form called Schedule C and the “bottom-line amount” from Schedule C is transferred to your personal tax return. Business losses may offset income earned from other sources.

Sole proprietors must also file a Schedule SE with the 1040. The Schedule SE is used to calculate how much self-employment tax you owe. You do not have to pay unemployment tax on yourself, but you must pay unemployment tax on any employees if you have them.

Sole proprietorships seem like a no brainer to eager entrepreneurs. There are many perks and the lack of government regulation and simplicity are definitely attractive. However, because your business and personal finances are combined and you have no liability protection, you must be careful not to upset your personal life. It can be risky but if you educate yourself and consult with qualified professionals to ensure you are on the right track , sole proprietorship is a great way to get started in business.

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