Advantages of a sole proprietorship for startups and small businesses
A sole proprietorship is the easiest type of business to set up and the ideal starting point for many budding entrepreneurs. It costs little to nothing to register, income and losses are reported on personal tax returns, and owners have complete control over all business decisions.
It’s also one of the most popular business structures, no doubt due to its simplicity. The U.S. Small Business Administration (SBA) reports that 86% of single-employee businesses operate as sole proprietorships across an array of industries. Consultants, beauticians, ecommerce sellers, nannies, writers, designers and landscapers — to name just a few — make up the ranks of sole proprietors.
Part-time enterprises factor in, too. About 50% of millennials perform freelance work, according to Upwork, and Bankrate reports that 44 million U.S. adults operate a side-gig. Most of these independent operators fall under the banner of sole proprietor.
In fact, simply selling goods or providing services — even without a formalized business — makes you a sole proprietor in the eyes of taxing and legal authorities. If this is you, or if you’re ready to enter the world of small business ownership, you can register a sole proprietorship in just a few steps.
Setting up your sole proprietorship
Business setup, licensing and permitting processes vary by state. In many cases, you’ll register a sole proprietorship at your city hall or county clerk’s office. This may be free, or you may incur filing fees or other costs for business permits and industry-specific licensing. Your local SBA Small Business Development Center can help with specifics in your area.
Following registration, you’ll want to:
It’s also wise to consult with an accountant, lawyer and business insurance agent to ensure you’re covered on the financial, legal and liability fronts from day one.
Protecting yourself under a sole proprietorship
Liability exposure is a major downside of this popular small business structure. Sole proprietors carry personal liability for their business and financial decisions. If a client, vendor or creditor sues you, they can attach — and win — personal assets including your savings, personal property and even your home.
Likewise, businesses that directly impact their customers’ health, property and financial well-being aren’t the best candidates for sole proprietorships. Plumbers, electricians, mechanics, caregivers, contractors and even some types of consultants can lose their personal assets if people or property are adversely affected by their business decisions.
Also, if your company goes bankrupt due to lawsuits or business failure, it’s a mark against your personal credit. Under a sole proprietorship, there’s no separation between you and your business in the eyes of creditors.
Rob Stephens, business owner and founder of CFO Perspective advises those choosing the sole proprietorship route to “make sure you have strong, broad insurance coverage with high insurance limits.” Stephens also advises to “use an attorney to draft customer agreements that protect you to the fullest extent possible.”
Financial benefits of a sole proprietorship
Despite the liability drawbacks, some small businesses choose the sole proprietorship route for financial reasons beyond its low-cost setup.
According to Shayne Sherman, small business owner and CEO of the tech firm TechLoris, “sole proprietorships are a good option for start-up, part-time and side-gig businesses that might incur losses.”
If your business is successful, you’ll pay self-employment tax on the profits earned under your sole proprietorship. So, it’s important to carefully track all of your business expenses.
Alternatives to a sole proprietorship
There are several alternatives to sole proprietorships and all offer greater protection by separating your personal assets from your business’s legal and financial liabilities. These are, legally speaking, standalone entities, and require more setup, legal compliance and tax management.
It’s best to seek advice from both an attorney and an accountant when considering these options.
Single-member limited liability company (LLC)
In legal terms, a single-member LLC offers the limited liability of a corporation with pass-through taxation. What that translates to is, essentially, a sole proprietorship on liability protection steroids.
LLC management and taxing closely mirror a sole proprietorship — meaning you control your business and your profits and losses flow onto your personal taxes. However, your personal assets are better protected from business-related legal claims. Forming this popular alternative to a sole proprietorship generally costs just a few hundred dollars.
S Corporation (S Corp)
Like an LLC, an S Corp offers corporate limited liability protections with pass-through taxation onto your personal taxes. An S Corp is more complicated to set up and maintain than an LLC, but generally a better option if you plan to hire employees. In addition, if your business is highly profitable, it can lower your self-employment tax burden.
More complex business structures like C Corporations and partnerships offer liability protections as well. However, the cost, accounting requirements and compliance upkeep of these structures generally outweigh the benefits for small operators.