A business entity is an association that employs economic inputs or resources to provide customers with services or goods in exchange for money.
Planning to start your own business? Congratulations on starting your new journey as an entrepreneur! Entrepreneurs like you are truly fuelling the economy. Since businesses take various forms of ownership, the most common question among entrepreneurs is what type of business I should form? Certainly, the confusion surrounding this question hinders many business ventures before even start.
Take notes because this is crucial to the foundation of your new business. Let us take a critical look at one of such businesses – “Sole Proprietorship”.
What is a Sole Proprietorship?
It is a type of enterprise that is owned and run by an individual. In other words, it is an unincorporated business with an owner who pays income tax on profits earned from the business. The best part about Sole Proprietorship is that there is no legal distinction between the owner and his business entity. The owner is in straight control of all factors and is legally liable for the finances of the business; it may include loans, debts, loss, etc.
Hence, with very less government regulation, a sole proprietorship is the easiest and modest business to set up. Sole proprietorships are most popular among small business owners, individual self-contractors or consultants. Usually, sole proprietors prefer doing business under their own names since forming a separate business name isn’t required. For a more clear approach, you need to understand the characteristics, advantages and disadvantages of starting a sole proprietorship. Check them below:
Characteristics of Sole Proprietorship
The sole owner controls and maintains all the operations of the business on his own, without anybody’s interference. He can solely plan his strategies and decide the growth of his business.
In Sole Proprietorship, the liability of the owner is unlimited, which means that if required, the owner can sell his personal property for the recovery of his debts.
No Legal Status of the Business
No separate legal entity is required from the business owner in a Sole Proprietorship. This way the life of a business depends on the life of the proprietor if any mishaps happen the sole proprietor can end the life of his business.
Sole proprietorship is very flexible and can be changed according to the nature of the business. You can add or reduce the services depending on your choices.
For a sole proprietorship, the business owners do not need to file their taxes under employee identification number. The income earned from the business is considered the personal income of the proprietor for taxation. Hence, the owner is responsible for paying taxes to the Income Tax Department, if the income becomes taxable.
Accounting Status of the Business
To keep the accounting status of the business transparent, it is advisable to keep the record of the business and personal transactions separate. It assists in checking the true results of your business operations.
The sole proprietor of the business bears all the business risks. Sole proprietorship has less restrictive regulations, unlike corporations and partnerships. A business owner is required to register the business name and its operations.
Each business has its own success plans which include sales, marketing, production techniques or distribution strategies. To remain competitive in the market, the factors for your successful business should be kept secret. Since the ownership is in the hands of an individual, there are fewer chances of disclosing the secrets.
Advantages of Sole Proprietorship
Ease of formation
It is very convenient and affordable to start a sole proprietorship when compared to other business organizations. One can name the sole proprietorship after the owner, or it can be given a fictitious name to improve the business’ marketing.
In a Sole proprietorship, the owner can hire employees, which can lead to many of the benefits associated with job production, such as tax breaks. Moreover, the spouses of the business owner can become the company’s employees without any formal declaration. A married couple can also begin a sole proprietorship, but one individual can only assume liability.
The sole proprietor is responsible for all the decisions related to the business. The owner can also completely transfer the sole proprietorship according to his will at any time.
The business owner is not obligated to file an independent business tax report. Instead, they can list the business figures and information on their tax return. This saves the extra costs on tax-filing and accounting. In Sole Proprietorship, the taxes will be applied at the rates of personal income, not corporate tax rates.
Disadvantages of Sole Proprietorship
The continuity of sole proprietorship relies on the life of the business owner. In case of any fallout with the owner, the business no longer continues. Upon the owner’s death, the business becomes part of the owner’s personal estate and is included in the property that is meant to be distributed to beneficiaries. This may further result in heavy tax outcomes on beneficiaries due to the estate and inheritance taxes.
The sole proprietor is directly responsible for any violations, debts or losses from the business.
Difficulty in Raising Capital
It can be difficult for the owner to generate any further capital since he is the only investor in his company. Sole proprietorships do not distribute stocks or any other money-generating investments like a corporation does.
Lack of Public Confidence
The people may show less confidence in this type of organizations since there is no legal registration in controlling and winding up all the business.
It is difficult to expand a sole proprietorship in the initial years because some business owners rely on loans and due to the limited capital it can become a challenging task.
A Final Checklist for Setting Up a Sole Proprietorship
- Ownership rules: One business owner can plan to open a business.
- Management of the business: Sole proprietor operates the business.
- Essential documents needed for formation: DBA filing and business license
- Capital contributions: Sole proprietor provides whatever capital is required.
- Personal liability of owner: The business owner has unlimited personal liability for the commitments of the business.
- Tax treatment: The business entity is not taxed. All the profits and losses are transferred to the sole proprietor.