This is our second post in our series on Types of Business Entities. In it, we'll be discussing the advantages and disadvantages of Sole Proprietorships.
According to the State of Washington Business Licensing Service;
"A Sole Proprietorship is one individual or married couple in business alone. Sole proprietorships are the most common form of business structure. This type of business is simple to form and operate, and may enjoy greater flexibility of management, fewer legal controls, and fewer taxes. However, the business owner is personally liable for all debts incurred by the business."
Examples of sole proprietors include small businesses such as, a local grocery store, a local clothes store, an artist, freelance writer, IT consultant, freelance graphic designer, etc.
In our first blog post of this series, we mentioned that there are certain areas to consider when deciding on the best structure for a business. In this post we'll take a look at these areas again and discuss the advantages and disadvantages of sole proprietorships.
Areas to Consider:
We mentioned, in our prior post, the following areas to review when contemplating business structures for your company:
- Effort
- Tax
- Documentation
- Control
- Funding
- Liability
Effort:
Sole proprietorships are considered the easiest business entities to form and manage. The following are examples of ways they are simpler than other entities.
- Establishing a Business Name: It can operate under its owner's name, or a made up trade name.
- Business registration: Acquiring the appropriate license (s) or permit(s) and registering with the local government is all that's necessary.
- Ongoing Administration: There aren't reporting requirements, like that of a corporation, to weigh down on an owner's management efforts.
Tax:
In regards to tax, these business entities are subject to federal, state, local, and self employment taxes on their net profits.
Depending on their level of earnings, owners may want to consider the S-Corporation business structure for tax advantages.
Documentation:
Owners of these business types are able to report any income earned through their personal tax return requiring no separate business return and simplifying the tax filing process. There is less documentation since there isn't a requirement for a separate balance sheet.
Control:
Owners have full control over business decisions. In other words, the founder(s) have complete control over the company. While in partnerships, partners must come to an agreement and other structures involve shareholders. They have the advantage of being able to make decisions on the spot. No formal decision or evaluation processes are necessary.
This also contributes to the flexibility of the companies reducing any extra managerial efforts.
Funding:
For these business entities, owners have only two options for funding. They can only use their own assets or take out debt. Whereas partnerships, for instance, can split investment between partners. Other company structures have the advantage of selling stock.
Liability:
Owners are accountable for all their business's debts, losses, and liabilities. In other words, acting as a sole proprietor may not be in the best interest of an individual whose business exposes them to risk of debt or lawsuit. Being accountable for all their business's liabilities means their personal assets are at risk.
Overview:
- Sole proprietorships are available for individual owners (or married couples).
- Owners may want to consider other entity types for tax advantages.
- Some owners may prefer their simpler tax filing requirements with this business type. As well as the convenience of having less documentation requirements.
- Many owners may prefer complete control over their company.
- An owner should consider another entity type if they don't have enough wealth to start the company and do not want to take on the extra debt necessary to fund it.
- Owners should keep in mind that their personal assets are vulnerable to the risks involved in their company.
Stay tuned for our next blog post of this series where we will be discussing the advantages and disadvantages of partnerships.
