Sole Proprietorships – An Alternative to Incorporation
Do you cringe every time you are told that in order to start a business you need to incorporate? Do you feel like you and your business enterprise are not ready for the formalities, responsibilities and expenses that come with incorporation, and long for a less burdensome alternative? Have you thought about a sole proprietorship? No? Well, maybe you should.
A sole proprietorship is the quickest business entity type to form, and the simplest to manage. Any individual who is engaged in business that is not operating using an entity structure (such as a corporation or an LLC), and who is the sole owner of the enterprise, is operating as a sole proprietorship. In fact, many small businesses begin as sole proprietorships either unknowingly or by choice, and after operating for a period of time change their organization to a more recognized organizational form, such as a corporation. However, there is no requirement that forces a sole proprietor to make this change; it is a matter of preference when considering numerous factors.
For some, operating as a sole proprietorship has its merits, and it is just as legitimate of an entity structure as any of the others. However, though operating as a sole proprietorship certainly has some benefits, there are also some issues and concerns that any small business owner who is trying to decide what organizational form to proceed under should know.
First, let’s look at the benefits. As stated above, a sole proprietorship is the quickest business entity type to form, and it is the simplest to manage. To form, it takes no more than you, as the business owner, offering your goods or services for sale. In other words, there are no governmental formation filings required to form your sole proprietorship, and few, if any, ongoing reporting requirements, tax filings aside. (Note: business licenses, permits and other state, county and municipal approvals required for business operations are not included in the foregoing and are not discussed in this article and will likely be required no matter the business entity form you choose.)
If you plan to operate under a fictitious name (not your own surname), i.e. “Evergreen Landscaping Services”, you will be required to register your fictitious business name, or “DBA” (“Doing Business As”), with your county recorder or registrar. Your fictitious business name registration form will likely have a small filing fee associated with it, and possibly renewal requirements, but the burden as to your finances and time is minimal. If you plan to operate under your own surname, i.e. “Joe Smith Landscaping Services” or “Smith Landscaping Services”, you do not need to register your fictitious business name, or “DBA” (“Doing Business As”), with your county recorder or registrar. Additionally, as a sole proprietorship, you are not required to file yearly information statements with the state, hold meetings and maintain a book of the minutes, elect a board of directors or maintain a record of an agent for service of process with the state. No requirements force you to open a separate bank account, and incur the extra costs related thereto. Customers make payments to you, in your name (or your DBA), and you deposit the funds into your own bank account. Though for accounting and tax purposes you will want to keep track of your earnings and your business expenses, and a business checking account will help with that, there is no general requirement that you open such an account.
A sole proprietorship is taxed at the individual level, and not at a separate corporate level. Therefore, the concern about double taxation that comes with some other organizational forms, such as corporations, is not at issue with a sole proprietorship. This result can also be achieved in other forms of business organizations, such as partnerships, LLCs and S corporations – but, unlike some or all of those business forms, a sole proprietorship does not require other mandated tax payments. As you can see, the benefits to operating as a sole proprietor are centered on ease of formation, simplicity in formal operation and no double taxation. However, as with most things in life, the more simplistic nature of the sole proprietorship means that to get those benefits, there are trade-offs that must be considered.
First and foremost, the personal liability of the owner for all business liabilities that comes with a sole proprietorship will be the biggest concern that any small business owner will need to consider, mull over and seek out professional advice on before opening shop. Under a sole proprietorship there is no personal liability protection. The debts and liabilities of the business are the debts and liabilities of the owner, and vice versa, as the business and the owner are one in the same. A business creditor may seek collections against the business owner personally, going after the owner’s personal assets, even if the debt derives from business operations.
Moreover, judgment and tax liabilities from business related lawsuits and operations are also the personal responsibility of the owner, and the owner’s personal assets are at risk. Therefore, before beginning operations as a sole practitioner the small business owner should carefully and thoroughly consider what types of risks are involved, and what types of liabilities may arise in the particular area of business the owner plans to operate.
For example, an online retailer start-up who plans to use drop-shipping services (and therefore has little to no inventory) may have a much different view on their risk of liability than a start-up limousine rental company. While the owner of the limousine rental company can, and certainly should, obtain insurance to limit their risk of exposure to potential liability, the insurance is not a shield against personal liability and the owner will still be liable for anything the insurance fails to cover. Thus, if your business will have more than a small risk of liability exposure, a sole proprietorship may not be right for you.
Other issues to consider are lack of anonymity and the potential difficulty in raising capital as investors are unlikely to be willing to invest in your business without some form of ownership interest.
Putting everything else aside, the lack of personal liability protection that is inherent in a sole proprietorship structure is the most influential factor in steering small business owners away from sole proprietorships when deciding what organizational form under which to organize. However, as discussed above, that issue may not be one that serves as a roadblock to operating as a sole proprietor in some situations, especially when the financial costs and formalities of operating under other organizational forms are considered. Starting your business as a sole proprietorship could be an attractive option for your business, and, after consulting with your tax and legal advisors, you may find that it is the best fit for you.
Want to learn more about Sole Proprietorships and other business entity choices? Click here.