Top Sole Proprietorship Advantages and Disadvantages

🌟 KEY TAKEAWAYS

A sole proprietorship is an unincorporated business owned by an individual.

A sole proprietor has autonomy over their business.

Compared to other business structures, sole proprietorships are simple and inexpensive to set up.

A sole proprietorship must keep records and file and pay taxes.

A sole proprietorship is liable for all business debts and creditors can seize your personal assets.

It can be difficult to acquire financing as a sole proprietorship.

Working for yourself has some serious perks. But between choosing a business structure and figuring out your tax obligations, getting started can come with a lot of questions.

If you’re a freelancer, solopreneur, or just someone with a great idea and no interest in incorporating, a sole proprietorship might be the simplest way to make it official. A sole proprietorship is an unincorporated business owned by one person, like a tradesperson, freelancer, or founder testing out a new venture. Like any business structure, it has advantages and disadvantages.

So how do you know if a sole proprietorship is right for you? In this article, we'll walk through the top sole proprietorship pros and cons to help you decide.

What is a sole proprietorship?

A sole proprietorship means that you and your business are legally the same entity. You don’t need separate registration or formation paperwork as you do with an LLC or corporation. That’s a big part of what makes it the go-to structure for freelancers and solopreneurs just getting started. In fact, sole proprietorships make up 86.3% of businesses without employees in the U.S., according to the U.S. Small Business Administration (SBA).

Your business structure determines how you report your income and which tax forms you use. And because a sole proprietorship isn’t a separate legal entity, you’re personally liable for any business debts.

Advantages of a sole proprietorship

Starting a business can be exciting and intimidating. Before we get into the trade-offs, let’s look at what makes a sole proprietorship such an appealing entry point for solopreneurs and small business owners.

1. It's easy and inexpensive to set up

One of the top advantages of a sole proprietorship is that it’s easy and inexpensive to start, regardless of the type of business. It's a flexible option for those who are just starting out or running a side business. 

A sole proprietorship requires less paperwork than other business structures. You can register your ‘doing business as’ (DBA) name, but it's not necessary if you plan on doing business in your name. You will need an employer identification number (EIN) if you plan on having employees.

Your state and local government may also require business licenses and permits, depending on the nature of your business.

2. You have complete control over decisions

As a sole proprietor, every business decision is yours to make. There’s no board of directors, partners, or management layer to sign off on new ideas. That means you can pivot quickly if an opportunity comes up, test a new product, or change direction entirely without waiting on anyone else.

That extends to the people side of the business, too. Hiring, firing, and other business relationships are entirely up to you.

3. Tax filing is simpler

Filing taxes as a sole proprietor is fairly similar to filing as an individual. In the U.S., sole proprietors report business revenues and expenses on their personal tax return rather than filing a separate business return.

In the U.S., sole proprietorships may also qualify for the Qualified Business Income (QBI) deduction, which lets you deduct up to 20 percent of your QBI from taxable income on your personal tax return. This deduction has complicated rules around eligibility and income limits, so it’s a good idea to work with a tax professional to see how it applies to your situation.

4. Startup costs and overhead are lower

Another benefit of a sole proprietorship is the reduced business expenses when compared to other business entities. A small sole proprietorship will have lower overhead costs in day-to-day operations and yearly expenses. You have lower bookkeeping or accounting fees than partnerships and corporations. You also don't have to pay the costs associated with annual registration fees and corporate documents. In this way, a sole proprietorship is more cost-effective compared to other models.

5. Banking is simpler

You don’t need a dedicated business bank account to operate as a sole proprietor. Technically, you run business income and expenses through your personal account.

However, using a separate business account makes life easier at tax time. It’s much simpler to track income and expenses when they’re not mixed in with your grocery runs and coffee habit. Tools like FreshBooks can connect directly to your bank account so your transactions stay organized without extra manual work.

Disadvantages of a sole proprietorship 

Sole proprietorships can be a flexible way to start small and grow operations. However, sole proprietorships have disadvantages beyond being solely responsible for operations, strategy, and customer demands.

1. Lack of liability protection

Unlike a limited liability company or corporation, a sole proprietorship doesn't legally separate you from your business. That means you’re personally on the hook for business debts and legal claims. If someone sues your business or you can’t pay the business debts, creditors can potentially come after personal assets, like your home, car, or savings.

Compare that to an LLC or corporation, where the business and the owner are legally separate, and there’s little risk of losing your personal assets to cover business debts or legal obligations. As a sole proprietor, there’s no legal wall between you and your business. That’s one of the biggest risks of this structure.

2. It's harder to secure financing and credit

Lenders tend to favor businesses with an established track record and credit history since it’s easier to assess the risk. As a sole proprietor, your business’s financial history is tied to your personal history, making it harder to build separate business credit. If your personal credit history isn’t strong, securing a loan can be tough, regardless of how well the business is doing.

You also have fewer ways to raise capital compared to a corporation. You can’t sell equity in your business to bring in investors, so growth might be limited to what you can fund yourself or borrow on personal credit.

3. Difficulty in Selling the Business

Selling a sole proprietorship is trickier than selling a corporation or LLC. Since the business isn’t a separate legal entity, what you’re really selling is physical assets and equipment. You may also be able to sell intangible assets like intellectual property, customer lists, and your brand reputation, but these are harder to transfer since there’s no clean way to separate you from the business in a sale.

4. High self-employment tax burden

In the U.S., sole proprietors pay self-employment (SE) tax to cover Social Security and Medicare. Since there’s no employer to split those costs with, you’re responsible for both the employer and employee portions. Currently, the SE tax rate is 15.3 percent, applied to 92.35 percent of your net self-employment income. You can, however, deduct half of what you pay (the employer-equivalent portion) when calculating your adjusted gross income.

5. No board of directors

Corporations have a board of directors to guide strategy and keep the company accountable for following relevant laws and regulations. As a sole proprietor, you don’t have that built-in support system. Every decision (and every mistake) is yours alone.

For a sole proprietor, the closest equivalent to a board of directors is usually an informal one, like a mentor, mastermind group, or advisor you trust to be a sounding board when you need one.

So, is a sole proprietorship right for you?

There are sole proprietor advantages and disadvantages with every decision in business. The right decision depends on what’s best for your business in the short and long term. When you have all the information and have weighed the pros and cons, you can make an informed decision for your company and future success. 

If your biggest concern in starting a sole proprietorship is a lack of support, FreshBooks Accounting Software for Self-Employed has you covered. We have the features and tools to help you manage all aspects of your sole proprietorship including expense tracking, invoicing, and accounting. Try FreshBooks free by signing up today.