A sole proprietorship is a business structure owned by only one person. In this type of entity, there’s no legal distinction between the owner and the business — which means 1) the owner is entitled to all the profits of the business, and 2) he/she is also responsible for the losses, liabilities, and debts the business will incur.
A sole proprietorship is the most common type of business and the easiest to set up. Since the business does not become a legal entity separate from the owner, it can operate under the name of the proprietor. It is also possible to register a fictitious name for it, like Chef Anna’s Pastries — but the fictitious name is simply a trade name; it does not establish an independent entity.
If you would like to know the difference between common business structures (sole proprietorship, partnership, LLC, corporation, etc.) you can read the comparison we wrote here. If you’d like to know more about sole proprietorships, this article will help you see if it’s the right business type for you.
How to Set Up a Sole Proprietorship
According to Barbara Weltman, a business and tax attorney, “as long as you are the only owner, you automatically become a sole proprietorship by conducting business.” This means that it is not necessary for you to take legal or formal steps to establish a sole proprietorship. But if you are going to put up a shop or an office, you may need to secure a business and/or occupancy license.
If you choose to file your business name, very little paperwork is required. To do this, you just need to submit a completed “Doing Business As” form (to register your fictitious name) at your local courthouse. Fees and requirements vary by state, but these are usually very minimal. Once that is done, you will be given a certificate which you can use to apply for business bank accounts and credit cards.
Cost of Setting Up a Sole Proprietorship
As mentioned earlier, most times, you do not need to register a sole proprietorship at the local, state, or federal level. Sometimes though, depending on the municipality or city where you will setup your office or store, you may be required to apply for licenses. Costs vary depending on what license you need to secure and in what state you’re getting it from. For example, in Alaska, all businesses need a state business license that costs $50 per year.
Also, if you are to use a business or trade name that is different from your legal name, you will need to file your fictitious name with your county clerk or state secretary (depending on where your business is located). Filing fees also differ in every state. For example, it’s $5 in Washington, $10 in Arizona, $25 in Arkansas, $50 in Ohio, $70 in Pennsylvania, and $100 in Wyoming.
Advantages of a Sole Proprietorship
1. You keep all profits.
Because you are the sole owner of your business, there is no one you need to split profits with. How you use the money will be all under your discretion. Whether you reinvest it back into your business to expand it, start a new one, or use it for personal expenses — it’s all up to you.
2. You have complete control over your business.
You do not need to seek approval from other board members or shareholders when making decisions for the business. If you want to add new products or services, run promos, hire more employees, etc. — you have all the authority to run the show. Also, if you decide to sell the business or transfer ownership to someone else, you have full rights to do so.
3. It’s easier to file taxes compared to other structures.
Since you and your business are one and the same, you do not need to file a separate business tax report for your business’ profit and loss. You just have to submit an IRS Form 1040 for individual income tax return. Your income as an individual and your income from your business are considered the same and personal income tax rates will be applied, not corporate rates.
Disadvantages of a Sole Proprietorship
1. You’ll be held liable for any violations, debts, or losses.
You are directly responsible for anything that happens with the business. For example, if debts are incurred and the business is not capable of paying them off, you will be required to satisfy them from your personal funds. Also, if your employees commit unlawful acts on behalf of the company (even without your consent), you can be held liable and be sued.
2. You have limitations with raising capital.
Unlike corporations, you cannot sell shares or stocks in your business — which is one of the best ways to raise capital. As an individual owner, you are the primary source of your business’ funding. In cases when you have to turn to banks or financial institutions to take out a loan for your business, bear in mind that the lenders are limited to only your credit history as a basis for your loan approval.
3. Your business’ continuity depends on you.
The success of a business under a sole proprietor is closely tied to you, its owner. If you encounter illnesses or if you pass away, any remaining assets of the business will be liquidated and become a part of your personal estate. This will then be given to your beneficiaries (with imposed estate and inheritance taxes). In some cases, ownership is transferred to heirs — but without the proper knowledge to run it and without the loyalty of the customers’ to the previous owner, keeping the business may be a struggle.
Examples of Businesses that are Commonly Operated by Sole Proprietors
There are a lot of different kinds of businesses operated by sole proprietors. Home-based businesses, freelance service providers, independent contractors, and more are usually organized as sole proprietorships. Here are a few examples of service businesses that are often operated as sole proprietorships:
Qualified plumbers who opt to become self-employed — seek their own clients, decide their own rates, set their own work hours, provide for their own equipment — and not work for someone else’s company is a sole proprietor.
This is also a service-based business when a bookkeeper decides to go solo, instead of being employed by a company. A bookkeeper can do business under their own name or register a business name — but the structure will still be a sole proprietorship.
Some photographers work as independent freelance contractors, while others start their own photography studios. Some choose to work with retail clients like families who need portraits, couples who need wedding photos, debutantes who want to capture their coming-of-age, etc. While others work with corporate clients for product shoots, magazine covers, AVPs, and more.
A sole proprietorship is a good way to get started with your business. Since setting it up is easy and requires minimal costs, it is ideal for those who have limited capital and resources. It also allows proprietors to have full control of their business.
Although there are disadvantages that come with this structure — most importantly the fact that the business does not become a separate legal entity and the owner can be held liable for losses, debts, or violations incurred by it — it can be migrated to an LLC or corporation structure later on. If you want to learn more about the differences between these business structures, you can read our business structure comparison guide.