What Are the Disadvantages and Advantages of a Sole Proprietorship?

Advantages

People who like to be their own boss without answering to anyone find sole proprietorships the best possible business model. The sole proprietor has the freedom to do what they deem fit, and either reap the rewards of the toil, or bear the brunt of the mishaps alone. Such people find pride in owning an independent business that no one can take away from them, and aspire to create a legacy to pass on to their children or family.

The biggest advantage of sole proprietorships, however, is the no-hassle nature of operations. Starting a sole proprietor business is easy, with the only mandatory legal requirement being a business license from the local county office. A sole proprietorship moreover requires no additional paperwork or regulatory compliance. Public limited companies and corporations, for instance, are required to hold regular board meetings and file periodic reports and statement of accounts. The sole proprietorship can do as it pleases, and if it wants to, can even run without maintaining any accounts.

All the profits that stems from a sole proprietorship are that of the entrepreneur and are included with the entrepreneur’s income tax returns, without having to file a separate income tax return for the business. In addition, the sole proprietor can write off almost any expense as part of business expenses, thereby reducing the tax liability. A corporation, on the other hand has to file separate returns and depending on the type of entity may have to pay separate tax on profits depending on percentage of ownership or shares.

Sole proprietorship allow for an easy exit route for the entrepreneur. The sole proprietor can close the business anytime without much hassles other than clearing all outstanding liabilities. Closing down a partnership or a corporation, on the other hand is a complex affair and requires the support and cooperation of other business partners.

Disadvantages

The advantages notwithstanding, the sole proprietorship structure come with many disadvantages and limitations.

The biggest danger of sole proprietorships is unlimited liability. A sole proprietorship does not distinguish between the entrepreneur’s personal assets and the business assets, and any liabilities that arise during the course of the business puts the personal assets and unrelated income of the entrepreneur at risk. Such risks become a major issue as the business grows and becomes increasingly visible. The only means to side step such issue is to switch over from a sole proprietorship to other business models such as Limited Liability Company (LLC) or an S Corporation.

Raising capital is difficult for sole proprietorship concerns. A sole proprietor’s ability to raise capital depends solely on the merit of personal financial standing whereas a corporation can pledge its shares to obtain the necessary finances.

An associated disadvantage of sole proprietorship is the limited tax deductions. The sole proprietorship cannot, for instance, take advantages such as setting off insurance amounts from income tax computations, available for corporations.

A review of the disadvantages and advantages of sole proprietorships reveals it as a business model that suits most small businesses with little risks. As the business grows and acquires critical mass, other models such as an LLC or S Corporation become more suitable.

Reference

University of Richmond. “Sole Proprietorships.” Retrieved from https://law.richmond.edu/about/centers/ip-clinic/business-sole-proprietorship.pdf on March 03, 2011.

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