Knowing the advantages and disadvantages of sole proprietorship helps you decide if it’s right for your company.
When you start a business, the type of entity you select to form your business affects compensation, taxation, liability, accountability, and dissolution or bankruptcy. This article will outline sole proprietorship advantages and disadvantages. It comes from the office of noted Springfield bankruptcy attorney David Offen.
Types of Business Entities
Before we dive into the sole proprietorship advantages and disadvantages, it helps to understand your business entity options. Below is a brief description of popular entities. CFO Perspective has a Business Structure Selection course that goes into more detail on the benefits of each business structure to help you decide which option might be best for your business. It’s just one of the dozens of downloads, courses, and videos in the Finance And Strategy Toolkit (FAST).
You can register your business as one of the following entities in the state where the business is located:
The business is owned and operated by a single owner or jointly owned by a married couple. The owner’s personal finances and business finances are one and the same for tax purposes. The owner may do business or trade in their own name, or select a trade name and “do business as” (d/b/a) that name.
There is no need to register a sole proprietorship with the state. However, depending upon the product or service you provide, you may have to register to obtain permits or licenses or to pay state sales tax. You may also want to register a sole proprietorship to protect your business name and brand and to build credit in the business’s name.
A General Partnership is a business owned by two or more people. A Limited Liability Partnership is structured to protect the partners from liability. Either may be taxed as flow-through entities, allowing partners to both share in the profits and absorb the losses. However, in some states, each partner is jointly and severally liable for the negligent actions of the other partners.
Partners should consider drafting and executing a partnership agreement in order to protect the business from disagreements between partners and provide exit procedures.
Again, there is no need to register a partnership with the state. Depending upon the product or service you provide, you may have to register to obtain permits or licenses or to pay state sales tax.
Limited Liability Company (LLC)
If a business is registered with the state as an LLC, all owners, called “members.” They are shielded from liability for the actions, products, or debts of the business. An LLC may be a flow-through entity or taxed as a corporation. A Professional Limited Liability Company is an LLC for professionals such as doctors, lawyers, and the like. An LLC may have one or more members.
A C Corp is an incorporated business consisting of shareholders (owners), directors, and officers. It’s subject to strict rules regarding accounting, and records. A C Corp’s profits are taxed and employees and shareholders are then taxed on their income. Owners, directors, and offices are shielded from liability for the actions or products of the business in most cases.
An S Corp is an incorporated business that is taxed as a pass-through entity, like a sole proprietorship and some LLPs and LLCs. A Professional Corporation is an incorporated business for professionals such as doctors, lawyers, and the like.
A Closely-Held Corporation, also called a closed corporation, is a firm whose stock is held by a small number of people such as a family or other insiders.
Sole Proprietor Advantages
- A sole proprietorship is simple and inexpensive to start. You need not register with the state unless you want to or the type of service or product you offer requires licensure or permitting.
- A sole proprietor has complete control of the business and makes all decisions, making business operations more nimble.
- A sole proprietor need not adhere to corporate formalities or paperwork, such as drafting and adhering to bylaws, holding required meetings, or recording the minutes of those meetings.
- Filing tax returns is easy for a sole proprietor. In most cases, simply complete a “Schedule C – Profit or Loss From Business” and attach it to your 1040.
- A sole proprietor can deduct most business losses on their personal tax return.
- Inexpensive small business insurance bundles are available to cover most risks of loss due to accidents, natural disasters, professional errors, product liability, premises liability, and workers’ compensation claims.
- If the business is struggling, a sole proprietor can file Chapter 13 bankruptcy and reorganize both personal and business debts.
- A sole proprietor can discharge personal liability for business debt as well as personal unsecured debt in Chapter 7 or Chapter 13 bankruptcy.
- A sole proprietor can use Chapter 7 to liquidate and close one business and thereafter start another business offering the same product or service or a different product or service.
The Disadvantages of a Sole Proprietorship
- A sole proprietor is responsible for all aspects of the business and its success and failures. If the business takes a loss, the sole proprietor has no one to share the burden of that loss. All other disadvantages of a sole proprietorship stem from the lack of separation between the finances and liability of the sole proprietor and the business.
- A sole proprietor is personally responsible for the business’ debts and other liabilities, such as a money judgment against the business. This means that if a sole proprietor is sued, their personal assets such as bank accounts, real property, and personal property are at risk. Purchasing a small business insurance package may lessen this risk somewhat.
- It is more difficult for a sole proprietor to build business credit and obtain business loans or otherwise raise capital because investors and banks see a sole proprietor as more of a risk than other business entities.
- If the business fails, it negatively affects the sole proprietor’s personal credit, and again, creditors of the business can pursue the assets of the sole proprietor to collect on business debt.
To Learn More about Sole Proprietorship Advantages and Disadvantages
Still have questions about the advantages and disadvantages of sole proprietorship? Sign up for the FAST membership to get the course on Business Structure Selection along with many other resources on business strategy, cash flow, and growth.
About the Author
Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with a busy Springfield bankruptcy attorney David Offen, Esq.
Note: The views, advice, information, and opinions expressed in guest post articles like this are those of the author. CFO Perspective does not verify the accuracy of such views, advice, information, and opinions. The purpose of these articles is to educate and inform. Please consult a qualified professional for advice specific to your situation.