A sole proprietorship is a type of unincorporated business that is operated by a single individual. Unlike a corporation, limited liability corporation (LLC), or limited liability partnership (LLP), in a sole proprietorship there is no legal distinction between the owner and the company. Sole proprietorships can also be known as sole traders.
Given their relative ease and low barriers to entry, sole proprietorships are a popular form of business, and constitute a majority of businesses in the United States. As with any type of business classification, however, there are numerous advantages and disadvantages to sole proprietorships that any new business needs to consider when choosing their classification.
When starting a business, entrepreneurs can be initially drawn to a sole proprietorship because of what it provides. This includes:
Sole proprietorships are faster, easier, and less expensive to start than any other type of business. Depending on the type of business and the state and local municipality, a business license may be required, but overall they require significantly fewer registrations and legal filings than incorporated businesses.
Generally, sole proprietorships have a lower tax burden than incorporated companies. They do not need to pay separate business taxes—any income can be treated as the personal income of the business owner, and paid alongside their other income at the same tax rates.
The administrative requirements of a sole proprietorship are far simpler to maintain, as ongoing paperwork requirements are minimal. In addition, sole traders do not need to obtain an Employee Identification Number (EIN)—instead, they can use their personal Social Security Number (SSN). They also do not need to possess a dedicated business account, and can instead use their personal bank accounts to process business revenues and expenses.
A sole owner has complete control over all business decisions, unlike in an incorporated enterprise, where there may be other owners, partners, board members, or stakeholders with just as much influence and power over a business’ operations.
While the ease of setup and maintenance of sole proprietorships are enticing for entrepreneurs, they also come with some drawbacks. Namely:
In a sole proprietorship, the owner assumes all debt obligations and legal liabilities of the company. Unlike corporations, LLCs, or LLPs, which are distinct legal entities that can shield an owner from personal liability arising from the business, sole proprietorships offer no such protection.
There is no legal distinction between the business and owner, so creditors can seek repayment from an owner’s personal property and assets. Likewise, the owner can be personally sued for any legal damages caused by the business.
Sole proprietorships can face more challenges in securing capital and fundraising than incorporated enterprises, as financial institutions are less likely to issue large business loans or lines of credit to private individuals than to established companies, especially since the owner is solely responsible for any outstanding debts. Nor can sole proprietorships issue stock to raise money, since sole proprietorships cannot be publicly traded.
Though there are risks with regards to personal liability and business funding, a sole proprietorship is an appealing choice for individual entrepreneurs due to its simplicity, tax benefits, and complete control. For anyone considering this business structure, it's essential to weigh these factors against their personal and business goals, and seek professional outlets when necessary.
