The simplest and most popular form of business ownership is the sole proprietorship. A sole proprietorship is a business owned and managed by one person. According to the Internal Revenue Service (IRS), sole proprietorships make up about 73% of all businesses in the United States (Internal Revenue Service 2010).
Advantages
1. Simple to Create & Dissolve
If you want to open a business under your own name, such as Smith’s Photography, you would simply obtain the necessary licenses from the state and your town, and begin operation. If you wanted to operate under a name that isn’t your name, you would file a trade name (also known as Doing Business As or DBA) with your town and the state so that the public would know the identity of the person behind the business.
When you decide you no longer want to run a business, you can close shop fairly quickly. Do keep in mind though, that you will still be personally liable for any outstanding debts and obligations the business cannot pay.
2. Least Costly to Form
Because of its simplicity, there is no need to create and file the legal documents generally recommended for partnerships and required for corporations. You (the entrepreneur) can usually go to your city/town hall, state the nature of the business you will start, and purchase the necessary business licenses.
In Connecticut, you are required to file a trade name with your city/town clerk if (as mentioned above) you operate under a business name that is different from your legal name.
Review our Starting Your Business Checklist article for additional items you may need to file based on your type of business.
3. Profit Incentive
One of the main advantages of this type of business form is that once you (as the owner of the business) pay for all of your company’s expenses, you can keep the remaining profits after taxes. The profit incentive is usually strong. Sole proprietors report the net income (what is left after expenses) of their business on Schedule C of IRS Form 1040, and the amount is taxed at your personal tax rate. Because you are self-employed, income from your business activities is also subject to self-employment tax. (Internal Revenue Service, irs.gov)
For the State of Connecticut, you would similarly file your income taxes under form CT-1040. If you expect to owe $1,000 or more in Connecticut income tax for the year, after taking into account any Connecticut income tax withheld from earnings at another job or from a pension, you should make estimated payments using form CT-1040ES. (CT Department of Revenue Services, portal.ct.gov/DRS)
Whenever there are tax implications as the ones mentioned above, you want to check with your accountant so that based on your personal circumstances, you can make the best decision as to whether this is the best business form for you.
4. Total Decision-Making Authority
You are in complete control of operations, which means you can quickly respond to changes in the market. This can be positive in a market that changes quickly. The freedom to run a company in whichever direction you see fit is often a motivational factor for business owners.
Disadvantages
1. Unlimited Personal Liability
This is perhaps the greatest disadvantage of a sole proprietorship: the business owner is personally responsible for all of the business’ debts. As the business owner, YOU are the business. You own all the assets, and if the business fails creditors can force the sale of these assets and use personal assets for fall back to recover payment if any debt remains. The reality here is that the failure of a business can ruin a sole proprietor financially.
This is why it’s so important to be as prepared as possible, and to fully understand your options prior to jumping in.
2. Harder to Raise Money
You have no shares to offer to an investor as a sole proprietor, you cannot count on a partner bringing in additional funds, and often banks are more hesitant to lend to a sole proprietor because of the perceived additional risk for repayment of a loan if the business fails.
3. Limited Skills and Capabilities
You do have total decision control, but that doesn’t mean you always have the complex range of skills necessary to run a business. We all have areas of strength based on our prior experiences, yet there are other areas where we may not be as confident. Business owners sometimes push aside problems they don’t understand or feel comfortable with, in favor of those they can solve easily, so be sure to either hire the talent that complements your abilities, and take advantage of no-cost resources like the CT Small Business Development Center.
4. Isolation
Yes, you get complete flexibility by being absolutely in charge, but you also may feel you have no one to turn to for help when solving problems or getting feedback on a new idea. Most sole proprietors admit to going through times where they feel the pressure of being alone and completely responsible for every major business decision.
Every business form has its advantages and disadvantages, and the first step in figuring out which one suits you and your specific situation best is to inform yourself. And don’t forget to talk to the professionals around you to get additional advice – when it comes to taxes and the law, your accountant and lawyer can guide you in the right direction.
If you would like to learn a little more before discussing with a lawyer or an accountant, reach out and connect with us. While we do not provide tax or legal advice, we can share more information with you so you feel better prepared for a conversation. In addition, we can provide a wide range of expertise and tools to support you in your entrepreneurial journey, from helping you refine your business idea to understanding the options to finance your business. Register here to connect to your local business advisor.