What Is A Sole Proprietorship, And What Are its Advantages And Disadvantages?

The sole proprietorship is the simplest and oldest form of business structure.  It’s also the most prevalent form because it is easy to create, transfer ownership, or dissolve.  Registration requirements depend upon the state that it is located in.  The owner can also choose a fictitious name, which allows him to open business accounts at banks in that name.

 Identity

The identity of a sole proprietorship and the business owner are one and the same which allows some definite advantages over more complex structures.  The operation of the business is centralized around, and controlled by the owner himself.  This makes the decision making process simpler with less need for discussions. 

Taxation

Profits from the company’s activities go directly to the owner, and are taxed on his own personal tax returns.  The revenues are taxed at the owners own personal tax rate.  This is a definite advantage compared to the double taxation that corporate profits receive.  A corporate tax is applied to business profits, and then dividends are taxed as income on the personal tax returns of shareholders.  You don’t have to be a C.P.A. to see the tax advantage to the difference between the two.

Unlimited Liability

There also disadvantages to having a single owner.  The most well known is unlimited liability for the debts of the business.  All of the debt that a business incurs from its activities is the sole responsibility of the owner.  This means that all of his/her personal resources are at risk for paying off creditors if necessary.

 Financing

Raising funds for the business needs of a sole proprietorship can also be difficult, as the credit rating of the business is the same as the owner’s own.  A personal bankruptcy on an owner’s credit record can make debt financing for the business particularly difficult.  Quite often an owner must use his or her own personal assets, which includes consumer loans.

Upward Mobility

Attracting qualified employees can also be difficult.  Employment with upward mobility might involve becoming a partner, which both parties might be reluctant to accept, especially since it would mean changing the legal structure of the business itself to that of a partnership.

 Business Risks

As a company grows, so do the business risks.  These risks can be reduced by spreading them out among more than one owner in the form of a partnership.  They can also be limited completely to the company and not the owners at all by forming a corporation.   Some sole proprietors do find other ways to deal with the higher risks due to growth, and their companies can become quite large.

A sole proprietorship is a good way to begin a business due to its ease of formation with many other definite advantages that make it appealing to many, including the administratively challenged.  Those that prosper and experience significant growth are offered other options to deal with these problems, which make for some interesting legal and accounting differences for those who appreciate those things.