Sole Proprietorship: Definition & How to Start Your Own Business

KEY TAKEAWAYS

• Out of all business types, a sole proprietorship is the easiest to establish. It has very little government regulation because it isn’t a separate legal entity. 
• A sole proprietorship is different from other business types because the owner is directly tied to it.
• Business owners take on the risk associated with the business, meaning there is no division between the sole proprietor and the business itself.
• If you own this type of business must file a Form 1040 and Schedule C annually with your taxes.

What Is a Sole Proprietorship?

A sole proprietorship is a business owned by a single person. It is an unincorporated business and the business owner has to pay personal income tax on all of the business profits. Most sole proprietors contract with businesses or work as consultants.

Characteristics of a Sole Proprietorship

A sole proprietorship is different from other business types because the owner is directly tied to it. LLCs and limited liability partnerships (LLP) offer separation between the owner(s) and the business activity. 

With a sole proprietorship, the business owner takes on business debt and responsibilities. The business is not separate from the owner in any way.

Advantages of a Sole Proprietorship

Easy to Establish

You only have to file a single form to establish a sole proprietorship. In addition to being easy, it’s also inexpensive to file. The only legal fees you need to pay include business licenses and permits related to your line of work. 

Simple Business Structure

Because you are the sole owner of the business with no governmental regulation, you have complete control. You make all business decisions and don’t have to consult with anyone else. You can change the business as needed and keep all profits for yourself.

Simple Finances

Business taxes are easy because the government doesn’t tax your business separately. You complete business forms and report business income on your personal tax return.

Disadvantages of a Sole Proprietorship

Personal Liability

Because a sole proprietorship is so simple there is no personal separation. If someone sues your business, they are really suing you. You are also personally responsible for debt and liabilities related to your business. This extends through all aspects of your business and leaves your personal assets at risk. 

Difficulty Raising Funds

If you need extra money to get your company off the ground, this type of business may not be right for you. Investors don’t often invest with sole proprietors. Instead they tend to lean toward larger business opportunities. You may have to scale your business independently. It’s also more difficult to get bank funding for your small business. With a sole proprietorship, loans are dependent on your personal credit.

Pressure and Burden

Being in complete control is great, but it also means you take on all of the stress. You are responsible for the success and failure of your business. Any business losses are also personal losses. With other business structures like a limited partnership, you share that burden with another owner. Your personal assets are also better protected.

Real-World Example of a Sole Proprietorship

Small businesses of all types often begin as sole proprietorships and evolve over time. For example, Rachelle Smith works as a freelance writer. She decided to establish a sole proprietorship as a common form of growing her business entity.

Over time, she takes on more work and needs to hire other writers. Soon, Rachelle’s business grows enough that she manages a team of other writers. Rachelle transitioned her business to an Limited Liability Company (LLC) for better protection over her personal assets. An LLC also allows her to pursue business lending and business investments.

Summary

Sole proprietorships are a great way for entrepreneurs to start their own business. 

Depending on what form of business you’re starting, they offer a steady and safe way into the business world. And can help any number of small business owners succeed.