Most people understand the idea behind a sole proprietorship. The term conjures up a mom-and-pop hardware store and the small café down the street. Many people, however, are not familiar with the advantages and disadvantages of operating a business as a sole proprietorship.
Anyone who is considering going into business should definitely consider the type of business structure that is right for his or her particular circumstances. In addition, anyone who is considering using a sole proprietorship for their business should understand the advantages and disadvantages before actually going into business.
One of the main disadvantages of a sole proprietorship is that it opens up the owner of the company to personal liability. Because a sole proprietorship is essentially a business being run in the name of the owner, that person is liable for any action against the company. In the eyes of the law, there is no wall of protection between the owner and the business. They are one and the same.
So, in a mom and pop hardware store, if a customer trips over the rakes and sues the store for medical bills, any judgment against the business could be collected from the owner’s personal assets—home, car, finances, etc.
One of the advantages of operating a business as a sole proprietorship is the lack of legal requirements to get started. As a sole proprietorship, the business is not required to register the business entity with the state and city. These types of documents usually require hiring an attorney to draft. In addition, registering the documents to establish the business entity also requires state and local fees. Being a sole proprietor saves the owner the cost of fees and an attorney.
Also, many states require that separate business entities pay a business or franchise tax each year—on top of income taxes. As a sole proprietorship, the business is usually not required to pay these taxes because there is not a separate business entity. The business is based entirely on the owner.
Credit and Financing
Another issue that is important to sole proprietorships is the issue of credit. If the owner of a new sole proprietorship is going to need financing from a bank to begin business, the credit record of the owner will be very important. Because a sole proprietorship is based on the owner, the owner’s credit record will be the sole basis of a bank’s credit evaluation.
This could be an advantage or a disadvantage depending on the unique situation of the owner. If the owner has excellent credit, then getting finance for a business will be somewhat easier. However, if the owner’s credit report is full of late payments and maxed-out credit cards, then getting financed for a business is going to be much more difficult.
In addition, should the business fail, the debts and liabilities are completely the responsibility of the owner. It is possible that the creditors could come after the owner seeking personal property or finances to repay the debts of the business. In addition, if filing bankruptcy is necessary to clear the debts of the business, that bankruptcy will be a personal bankruptcy affecting the owner and his or her personal credit report.
In the end, the owner of a business must decide if the advantages outweigh the disadvantages of a sole proprietorship. There is no one-size-fits-all business structure that can possibly suit every business type. The owner of a business should consult an experienced attorney or other business professional and understand all aspects of the type of structure before making a final decision.