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Benefits And Risks of Sole Proprietorship

Law Offices of Gretchen Cowen, APC June 10, 2024

Starting a business is an exciting venture, but the decision-making process when just getting started can be overwhelming. One of the first choices you as an entrepreneur should make is selecting the type of business structure.  

A sole proprietorship is often the go-to option for one-person start-ups. This type of business entity with one person as the sole owner and operator of the business may be ideal for small, low-risk businesses. While sole proprietorship may be an appealing option for entrepreneurs who want to kickstart a business, this structure has both benefits and risks of which you need to be aware of.  

At the Law Offices of Gretchen Cowen, APC, we help entrepreneurs with all aspects of business formation. With our personalized guidance, you can have peace of mind knowing that your business will have a strong foundation on which to grow.  

Our California business formation attorney can take the time to learn more about your needs and long-term goals to advise you as to which structure is the most beneficial to you.  

The Benefits of Sole Proprietorship

A sole proprietorship is a form of business entity with only one owner. With complete authority over every aspect of the business, the owner also bears all the responsibilities and liabilities. A sole proprietorship is a popular choice for many entrepreneurs, especially those just starting out, as it offers several benefits:  

  • Easy and cheap to establish. Unlike corporations or partnerships, which require extensive paperwork and legal fees, establishing a sole proprietorship involves minimal steps. In most cases, you don't need to register your business with the state. You can simply start operating under your name or a fictitious business name. With fewer bureaucratic hurdles and reduced legal fees, you can get your business up and running quickly, allowing you to focus on growth and customer acquisition. 

  • No corporate business taxes or double taxation. Taxation is often a major concern for new business owners. Sole proprietorships offer an advantage in this area by simplifying the tax process. Sole proprietorships' income is reported directly on the owner's personal tax return. This eliminates the dreaded double taxation scenario where income is taxed at both the corporate and individual levels. 

  • No annual reports or filings. Maintaining a corporation or LLC requires regular compliance with state regulations, including the filing of annual reports and other documentation. Sole proprietorships, on the other hand, benefit from fewer ongoing requirements. Without the need for annual reports and filings, you can spend more time focusing on your business and less on administrative tasks. Avoiding these filings also means avoiding the associated fees, contributing to the overall cost-effectiveness of a sole proprietorship. 

  • Fewer legal formalities and less paperwork. Operating as a sole proprietor comes with a level of simplicity that appeals to many entrepreneurs. You won't need to maintain extensive records of meetings, resolutions, or other formalities required of corporations. Since you're the sole owner, you have complete control over business decisions without needing approval from a board of directors or partners. 

  • Simple dissolution process. Business ventures sometimes don't go as planned, and ceasing operations may not be the easiest task if you own a corporation or LLC. Sole proprietorships offer an easier path to dissolution. If you decide to close your business, the process is relatively simple and requires fewer costs and legal fees, allowing you to move forward with minimal financial strain.  

These advantages make sole proprietorships the most common type of business entity in California. According to the Public Policy Institute of California, at least 3 million businesses in 2019 were sole proprietorships with no employees.  

The Risks of Sole Proprietorship  

While sole proprietorships offer simplicity, less fees to set up, and fewer bureaucratic hoops to jump through, they come with certain drawbacks that can impact your financial security and business growth. Understanding these risks is crucial for entrepreneurs looking to make an informed decision about their business structure:  

  • Unlimited personal liability. Unlike corporations or limited liability companies (LLCs), sole proprietorship does not provide a legal distinction between the owner and the business. This means that if the business incurs debt or faces legal action, your personal assets – such as your home, car, and savings – are at risk. 

  • Harder to get financing and business credit. Securing financing and business credit can be more challenging for sole proprietors compared to other business entities. Financial institutions often view sole proprietorships as riskier investments due to the lack of separation between personal and business assets. As a result, banks and investors may be more hesitant to extend loans or lines of credit to sole proprietors.  

  • Challenges in securing capital investments. If you aim to grow your business through capital investments, being a sole proprietor might pose a significant hurdle. Investors typically prefer investing in entities with a clear structure and limited liability, such as corporations or LLCs. When you own a sole proprietorship, there is no stock or ownership interest to sell, making it difficult to attract substantial investments. This limitation could impede your ability to scale your business and take advantage of growth opportunities in the future.  

  • Difficult to sell your business. Selling a sole proprietorship can be more complicated compared to other business structures. When you sell a sole proprietorship, you're essentially selling the business's assets rather than the business itself since there’s no legal distinction between you and your business.  

  • No operational continuity if the owner dies. What happens to a sole proprietorship when the owner dies is largely dependent on whether they had a succession plan or not. With no plan in place, any business assets become part of the owner's estate and are subject to probate while their personal assets could be used to settle business debts.  

For many, the numerous advantages of having a sole proprietorship are worth working through the disadvantages. Ultimately, whether or not this business structure is right for you depends on your goals, needs, and preferences. 

Can’t Decide on a Business Structure? We Can Help.

At the Law Offices of Gretchen Cowen, APC, we know that starting a business is a big step that requires meticulous preparation and strategic planning. We also understand that everyone’s business is different and the entity you choose will impact many things, including how your business is taxed and the degree to which you can be held personally liable.  

As a sole practitioner, our attorney provides personalized, one-on-one service and develops effective legal solutions tailored to each client. Let’s have a conversation today to discuss whether or not sole proprietorship is right for you.