The Pros and Cons of Sole Proprietorship for Entrepreneurs

Starting a business requires a lot of planning. One of the first things entrepreneurs should consider is which entity type would be the best choice for their budding business.

Entrepreneurs looking to start a business on their own typically become sole proprietors. This is often the most time- and cost-effective solution. But, it also has its drawbacks.

Let's get into sole proprietorship's advantages and disadvantages. It will help you decide whether it would be right for your new business, or if you should explore other entities.

What is a sole proprietor?

A sole proprietor, by definition, is a person who runs an unincorporated business. A sole proprietorship is a business entity type owned by a single person. The two are typically considered to be the same in the eyes of the law.

Small, individually-owned businesses will enjoy and appreciate the advantages of this entity type. For example, easy setup and full control over business decisions may be a priority for some entrepreneurs. There are, of course, disadvantages to sole proprietorship. However, as long as the pros outweigh the cons, you can always find ways to solve those.

What are the advantages of a sole proprietorship?

Most of the advantages revolve around its easy setup and registration process. For some, it's all about maintaining full ownership and decision-making rights within the business.

Sole proprietorships are also one of the most common entity types in America. Setting up this type of entity requires no significant up-front investment. Still, all the income goes to the owner, and they retain full control over how the business spends money. Sole proprietors may also be eligible for some tax benefits as well.

Let’s go through each of these in more detail.

Easy registration

One of the biggest advantages of sole proprietorship as your business model is that it’s the easiest to set up. It doesn’t require you to spend hours filling up paperwork to register your business with the state. Most of the other entity types require articles of incorporation, or at least a partnership agreement. As a sole proprietorship, you become a business by doing business.

You might need to get a permit or a business license depending on the product or service you'll be providing through your new business. Make sure to inform yourself on whether you need it, as it may also depend on your country or state.

Business ownership flexibility

Young businesses often have either a very clear vision for their future or are going in without a straight business plan. The latter may need a board of directors with the expertise to steer it in the right direction. A board would only slow down those that have a detailed business plan upfront.

If you have a clear and viable business plan for your business, the sole proprietorship is the right entity for you. You have complete control over every aspect of your business as a sole proprietor. You get to choose which products or services to offer and you can decide where to spend more and where to budget. You'll also have full control over how you’re advertising your business.

All the business decisions are in your hands with sole proprietorship. You get the freedom to execute your vision for your business without interference.

Easier budget and tax management

Another one of sole proprietorship advantages you should consider is that it’s fairly easy to manage your taxes and budget.

You’re not required to have a separate checking account or to register for an employer identification number (EIN). As a sole proprietor, you file your business’ taxes along with your personal ones on the ​​annual 1040 form.

While this is a great pro for sole proprietorship, it’s recommended to keep them separate. Try not to mix your personal and business taxes and finances, as it may be difficult to report them later.

Applying for an EIN has its benefits. For example, you’ll need an EIN to hire employees, which can be a great asset once your business starts to grow.

Having a separate checking account might also be beneficial. You will be filing your business taxes together with your personal ones. However, two checking accounts will make it easier to track your revenue and expenses so that you can accurately file at the end of the fiscal year.

What are the disadvantages of a sole proprietorship?

Most disadvantages of this type of business entity revolve around funding and liability. When you decide to run your business as a sole proprietor, managing funds will likely be more complex.

For example, if you decide to become an employee instead, you’re eligible for paid time off and benefits. If you are a sole proprietor, you have to plan your finances to include any sick days and vacations in advance.

Still, it’s difficult to pinpoint all the disadvantages of being a sole proprietor. These are often interpreted as pros by other business owners. However, here are some of the most commonly considered disadvantages of sole proprietorship.

Harder to get funding and limited lending

As a sole proprietor, you are responsible for revenue, providing your income, start-up money, and meeting operating costs. Most financial decisions are in your hands and you may face some common financial risks of the sole proprietorship.

You may have to navigate times of financial instability. As your business grows, you might also struggle to meet higher tax requirements than those set up for LLCs and Corporations. Or, you might try to get more funds to expand. But, without the option to offer stocks or shares to investors, this entity type might leave you only with unfavorable deals on the table.

While there are other options to get funding, it can be tricky to access funds and loans you’d be eligible for as an LLC, for example. Lenders look for businesses that have a good business score, as it helps them avoid risky loans.

Since sole proprietors use their checking accounts for business, building a good business credit score isn't easy. A poor business credit score might affect how lenders perceive you. This, in turn, may limit your sole proprietorship’s scalability. Even though the money may be needed for further growth, a poor business credit score will likely discourage lenders from providing it to you.

Selling your sole proprietorship business is tricky

Furthermore, selling your business might prove challenging. Sole proprietorship businesses are tied to the individual. You’d have to take some extra steps that LLCs wouldn’t have to bother with.

You can’t sell your business as a whole, and you’d have to sell business assets instead. Unless you’ve registered your business name under “Doing Business As (DBA)”, you cannot sell it or transfer usage rights.

On the other hand, one of the advantages of a sole proprietorship is that dissolving it is easier than with other entity types.

Personal liability in a sole proprietorship

One of the main sole proprietorship disadvantages is the unlimited liability it carries. If you decide to run your business as a sole proprietorship, you are liable for any debts your business may have. So, if your business profits can’t cover your business debts, your creditors may sue you personally. If it happens, you are fully responsible for paying them back.

The opposite also stands true - your business is not protected from your personal debts. Creditors may go after your business’ assets to compensate the funds you personally owe them.

Another risk in terms of personal liability is that sole proprietorships often don’t have insurance. This makes their owners liable for any injuries or torts that may occur due to the company’s acts or omissions. While it may put a strain on your budget, liability insurance for your business is something you should consider as a sole proprietor.

Tax implications of sole proprietorship

A sole proprietorship comes with its own set of tax implications. Depending on the profit your company makes, these can be either a benefit or a major disadvantage of sole proprietorship.

As this type of business entity, you will be taxed on all the profits of your business. To do this properly, you need to keep a strong record of both your business income and expenses. Plus, you need to keep these records separate from your records, as not everything is deductible. This is why it’s recommended for sole proprietors to have a business checking account, even though it is not required by law.

You are required to meet estimated taxes each year. Also, you must contribute self-employment taxes to Social Security and Medicaid. Depending on your profits, you might be eligible for a pass-through tax deduction under the Tax Cuts and Jobs Act.

Is sole proprietorship the right choice for your business?

Now we've explained the sole proprietorship advantages and disadvantages, making the right choice should be easier. When deciding on your entity type, consider each of these pros and cons carefully, as they may play a big role in the future.

The sole proprietorship is an easy entity to start and manage, but scaling it further might be difficult. You’re the only one who gets a say on all business decisions, but you’re also personally liable for all of your business' mistakes.

If the pros outweigh the cons for you, the sole proprietorship is likely the right choice at the moment. Still, keep your business's long-term goals in mind and inform yourself of other entity types before you start your business.

FAQ

Why is sole proprietorship better than partnership?

For some individuals, a sole proprietorship may be better if they wish to have full control over all the business decisions. It also means that a single person retains all the profits. The sole proprietorship is easier to set up, and there are fewer administrative requirements to do so when compared to a partnership.

Can a sole proprietor have two owners?

A sole proprietorship cannot have more than one owner. It’s a legal requirement since income and expenses from the entity are reported through personal tax forms. If two or more people want to start a business, they can still do so, but it would be considered a general partnership rather than a sole proprietor.

Can sole proprietors have employees?

Yes, sole proprietors can hire employees. To do so, sole proprietors must obtain an employer identification number (EIN). They must also have their new employee fill in the W-4 form so that they can withhold proper amounts from the employee’s paycheck for taxes.