A sole proprietorship is the most basic business model whereby a sole proprietor (exclusive owner of a business) enters into agreements under their own name. Under this business model, the exclusive owner of a business undertakes the full economic and legal reasonability of the business. The business is not a separate legal entity from the individual owner and therefore the owner is fully responsible for all actions of the business.
Unlike the more complex business model of partnerships and corporations, the simplicity of a sole proprietorship is an attractive feature as no formal fillings or registration events are required. A sole proprietorship is a status that automatically arises out of one’s business activities.
Sole Proprietorships Pros:
Sole proprietorships provide a business vehicle that is established instantly, easily and inexpensively in comparison to the other business vehicles. There is no requirement for registration filings making sole proprietorships very attractive business models. There are minimal legal costs incurred when forming a sole proprietorship, unlike partnerships and corporations that can involve initial fees.
Along with its simplicity and inexpensive setup, sole proprietorships give complete control and freedom to the owner. Its loose structure allows the owner to have complete control over the decision-making process. Along with this complete autonomy, the owner also has the right to receive all profits that the business may make, after the business’ creditors have been paid.
Perhaps the most attractive feature of sole proprietorships is the taxation structure. Profits earned by the sole proprietorship are taxed as the personal income of the owner. Therefore, any losses incurred by the business can be deducted at a personal level. Overall, sole proprietorships provide freedom, autonomy and taxation benefits to owners looking to start a business.
Sole Proprietorships Cons:
Since the sole proprietorship is not recognized as a separate legal entity different from its owner, there is a great deal of risk when carrying on business under the sole proprietorship business model. The sole proprietor can be held personally liable for all debts and obligations of the business. This risk extends to any liability incurred by any of its employees. Thus, the owner may be held personally responsible for things such as unpaid debts or legal actions that arise against the business.
For example, if a sole proprietor takes out a loan to operate, but then subsequently goes out of business, the sole proprietor will be liable for the amount of the loan and the creditor can come their personal assets in order to collect payment upon default. By comparison, corporations are separate legal entities that affords shareholders liability up to the amount of the investment. Therefore, where a corporation defaults on a loan, its shareholders are not legally responsible to repay such loan beyond the sum of their investment in the company.
Personal liability for an unpaid loan just scratches the surface of the potential liability of sole proprietorships. Another scenario that may arise is where a sole proprietor distributed a defective product resulting in some form of injury to the customer. The sole proprietor can be named personally in the action and liable for all damage caused by the actions of the business.
It is for these reasons that sole proprietors have such a difficult time finding investors. Investors are generally hesitant to invest in sole proprietorships because of the unlimited potential liability. With the sole proprietor not being able to raise capital through selling interests in the business, it is not an ideal model for a founder whose business may have financing needs.
Is A Sole Proprietorship Right for Me?
While the financial freedom, normality and autonomy offered by this business model are great advantages, the risks may sometimes outweigh the advantages. This is why it is extremely important, when choosing a business model for your business, to carry out a case-by-case analysis as every industry/business is different. Every business must be assessed on its own merits in order to effectively decide the best business model to be used. Businesses that operate in areas where the liability can potentially be exponential should likely opt into a safer business vehicle such as a corporation for maximum protection. Smaller industries that carry less inherent risks may be suitable to reap the benefits of the informal and free nature of sole proprietorships