A sole proprietorship is a single-owner business and the simplest form of business entity. However, a sole proprietorship is also the most restrictive form of organization for equity financing because the equity investment is limited to whatever personal funds you are willing to put into the business. Those funds may be already available in your personal financial portfolio -- from simple savings accounts at banks to ownership of commercial real estate -- or you may need to borrow more money and contribute those funds as an equity investment in your business. Debt financing for startup sole proprietorships is also typically limited by the amount of personal assets that the entrepreneur has available to pledge as security for a loan.
Advantages of Sole Proprietorships
- Exclusive control. You retain sole control over the management and development of your business.
- Cheap and easy to form and maintain. Almost no formalities are required to create a sole proprietorship (unless certain licenses are necessary for that type of business) and the administrative costs are minimal. Most states do require that if you operate your business under any name that is not your personal name, you need to file, in the local county where you will do business, a certificate that identifies you as the owner of that business. This certificate allows creditors to locate the people legally responsible for the business's affairs.
- Simple tax treatment. All income and expenses of the business are included on your personal tax return, usually on Schedule C. In addition, because startup businesses often operate at a loss during an initial period, the losses can be deducted on your personal tax return to offset income you earn from other sources.
Disadvantages of Sole Proprietorships
- Personal liability. Your business is not a separate legal entity and all business debts and liabilities are your personal obligations. You are personally responsible for the business's contracts, taxes, and the misconduct of employees or co-owners who create legal liabilities while acting within their employment. Although personal liability is a risk for sole proprietors, several considerations should be kept in mind. First, insurance may be available to minimize the effects of personal exposure for some of these liabilities. In addition, personal liability for business contracts is common in any form of small business -- the situation is not necessarily worse for sole proprietors. To minimize the risks associated with small businesses, customers, landlords, suppliers, and others will often require that the owner assume personal responsibility (sign a personal guarantee) for the business's contract, regardless of the form of your business enterprise.
- Limited financing options. The financing profile of a sole proprietorship is limited to the credit profile of the individual entrepreneur. If you are unwilling, or unable, to sell off any ownership interests in your business, you are the sole source of available equity financing. You may also have a difficult time obtaining debt financing, except to the extent you can pledge personal assets on a secured loan .
- Limited ability to engage in tax planning. All the income from the business is reported on the owner's tax return. There is no opportunity to retain cash within the business or to minimize self-employment taxes by splitting payments between salary and dividends.