Sole Proprietorship: Features, Merits and Demerits
If you’re working for no one but yourself, chances are that you’re a sole proprietor. It is the first form of business the average person goes into at the start as it’s so easy to manage. There’s more to a sole proprietorship which will help you improve your small business or start one. All the vital details including the features, classes, and how to start a sole proprietorship will be disclosed in a moment.
The features of a sole proprietorship
There are certain traits a sole proprietorship has that make it stand out. These features make it easy to spot and understand how a sole proprietorship works.
It’s a one-man (or woman) show
Sole proprietorships are famous for being owned and controlled by one person. It is not the type where two or more persons have equal say on the affairs of the company. One person plans the business, takes full responsibility, and molds the business in his or her likeness. It’s the type that can easily be passed down from generation to generation. One person is the sole signatory, stakeholder, shareholder, and administrator of this type of business. Many sole proprietorships are made in a way that just one person is enough to be both employer and employee without fuss.
The business owner and business are regarded as the same entity
The business owner is not separate from the business in a sole proprietorship. By law, whatever applies to one directly affects the other. There are instances where this can become a disadvantage. Since the business owner’s personal funds are the same as the company’s, then a financial dent could be catastrophic. If the proprietor has financial challenges, the business suffers; if the business suffers a financial hit, the owner suffers as well.
Little to no government regulation
A sole proprietorship is the form of business that could easily be unnoticed by the government in the region where it is sited. As a result, sole proprietorships get little attention from the government compared to others. The relatively small potential associated with most sole proprietorships makes the government pay little attention to them. Sole proprietorships are barely regulated by the government. Besides vitals permits that are required to run certain businesses, they operate with a certain freedom others lack.
Classes of a sole proprietorship
Sole proprietorship comes in three main forms which will be discussed shortly. These forms all follow similar features found in a sole proprietorship but they take different shapes. The types of a sole proprietorship include;
The business owner (Self-employed)
This form of sole proprietorship happens when someone sets up a small business to make ends meet. In such cases, people come up with ideas of what to sell or services to render for money. They own the tools for the business and they also own or have the place of business rented in their name as they manage it. The control they have over the business makes it very easy to manage. The business owner is completely responsible for the outcome of the business. Grocery store owners and barbershops are perfect examples of this form of business.
Franchise
A franchise is a sole proprietorship that has traits of a partnership. It is very common with startups that want to hit the ground running in no distant time. The challenges that come with opening a type of business make the business owners opt for franchising. Startups open their business under the name of an already established company and enjoy certain privileges. The franchisor (the one who approves the franchising) gets royalties from the franchisee. The franchisee also operates this business while adhering to certain conditions laid out in the contract with the franchisor.
Independent contractor
This type of sole proprietorship is common among people who work for others without being their staff. They have a certain level of independence as they determine most things about their business. An Independent contractor is a mix of entrepreneurship and being employed. While you work for another individual or company, they don’t treat you as their employees.
Examples of independent proprietorships are laborers and handymen. They are free to work with anyone they choose and they can bargain on a suitable fee. They work with the materials provided and in locations specified by their clients in many cases. Unlike the self-employed, independent contractors have no ties with the business. Whatever happens to the business is not their problem- they do their job and leave.
Pros of a sole proprietorship
For many reasons, a sole proprietorship is the best, and perhaps the most reasonable, the choice for any business starter. Most businesses start as a sole proprietorship and it is clear to see why with these advantages.
It’s the easiest to start
Anyone- yes, anyone- can start a sole proprietorship. A sole proprietorship is what you’re running when you decide to babysit or do a classmate’s homework for a few bucks. Anyone who’s ever done something for money, no matter the age, has run a sole proprietorship without even knowing it. That piece of information shows you just how incredibly easy it is to start a sole proprietorship. Some might say, “but I didn’t register or pay a fee, how’s that possible?” That’s how easy it can be. You just woke up one morning and decided to bake cookies for a dollar for a week; it’s a business you didn’t need to register for. Although one would need a permit for most types of businesses it’s not necessary in some cases. If a 5-year old can start a sole proprietorship, then what could be easier?
The owner makes executive decisions
It is one thing to be the boss, but it’s another thing to take all the vital decisions on your own. Vital decisions like staffing, wage structure, and control over business funds, are all made by the owner of a sole proprietorship. In corporations, vital decisions get to the notice of stakeholders before they’re approved. There are protocols to ensure that the business is run with fairness and transparency. A sole proprietor is allowed to be biased and self-centered in the course of running the business. While waiting to get approval from other members of the board in a corporation can be time-wasting, it’s the opposite here. A sole proprietor makes timely decisions as long as he or she thinks it’s the best for the business. You get to hire anyone or fire anyone you want in a sole proprietorship. A sole proprietor can ask staff to leave the business because of a personal matter, while in big organizations that would be nearly impossible. And while it could be against company policy for the business owner to take cash out of the business’s purse, it’s not the same here.
There’s little government interference
A sole proprietorship can easily fly under the government’s radar. The government rarely gets in the way of their business unlike other forms of business. For instance, freelancers can easily fly under the radar for a long time while making money but other established corporations will be closely monitored. Sole proprietorships don’t register their businesses for a long time until they feel the need to do so. Sole proprietorships hardly ever get any trouble from the IRS (or FIRS, depending on the region); they don’t even insist on the balance sheets. Apart from the necessary permits that depend on the type of business, a sole proprietorship is usually left alone.
The business owner calls the shots
Ever watched movies where you saw a wealthy businessperson being chased out of their own company after decades of hard work? Well, that doesn’t happen in a sole proprietorship. No one can come in and knock you off your perch because there’ll only be you calling the shots. The one who owns the business is the alpha and omega of the business and does whatever pleases him or her. If the business owner wishes to rent an office space, it’s mostly because he or she wants to. There’s no need to consult anyone before deciding between a sole proprietorship- here, the owner is god! The business owner employs whoever buys whatever, injects whatever into, and takes whatever they want from the business.
There is a lot of room for creativity
A sole proprietorship helps creative people shine because they don’t need the approval to do what they want. There are scores of creative people who started as a sole proprietorship but as soon as they switched, the owner couldn’t cope. It’s difficult for innovators to work in or run any other type of business when they have to get approval before doing anything. It’s in a sole proprietorship that one gets the leeway to “put their own spin” in the business.
Cons of a sole proprietorship
While the merits of a sole proprietorship make it the easiest and most convenient form of business to start, the demerits can’t be ignored. Some of the difficulties associated with sole proprietorship include the following;
It’s hard to raise capital
In the business world, raising cash is not easy for the “top dogs”, much less the startups. Starting a business could come up with its challenges and chief among them being raising sufficient capital. In raising capital, a business owner could get a loan or look for investors to help reach their goal. It would take some solid presentation and persuasion skills to get a loan or financial assistance of some sort for LLCs. A sole proprietorship would seldom get the same privilege. The way a sole proprietorship is structured makes it less appealing and somewhat risky to inject cash into according to investors. Most commercial banks will not loan money to a sole proprietorship, while those who will make tough demands. For this reason, most sole proprietorships end up getting funded by relatives and friends of the business owner. This process makes it difficult for a sole proprietorship to grow.
Personal liability
As a sole proprietorship, the business and its owners are the same. There’s no distinction between them legally as they’re regarded as the same entity. Since there’s no difference between business and owner, then whatever happens to one directly affects the other. This situation could easily be the biggest disadvantage of a sole proprietorship. The business owner, in most cases, uses his or her personal bank account for business transactions and this could lead to problems. Direct access to the business’s funds- both capital and profit- could lead to the misuse of business funds.
Also, in a case where the business is getting sued for some reason, the owner’s personal earnings and assets will be in the conversation. If the business is in trouble, the owner will bear the consequences. If unfortunately, the business collapses, the proprietor could lose everything they’ve worked for all their life.
A sole proprietorship misses out on the benefits of human resources
In every form of business, there are vital resources that are needed to keep it running. One of the most important resources is the workforce. The impact of like minds in an organization cannot be overlooked as it can easily be what sustains the business. A sole proprietorship has one Lord over the realm and in some cases, it’s just the business owner who’s running the affairs. Two heads, they say, are better than one; in business, the more the merrier. A business partner or associate would bring in expertise, clientele, and cash injection which would improve any business. Also, there is a bigger chance for business partners and associates to use their connections to create more opportunities. With their input, the business will grow to great heights. Division of labor will take some weight off a business owner’s shoulders and that can prove crucial in certain stages of a business. These are some of the benefits a sole proprietorship will miss out on.
How to start a sole proprietorship
Being the easiest form of business to start, the following steps are sufficient.
Decide on what business to start
If you must start a sole proprietorship, you must be sure it’s what you want to do. The first thing is to think about what business to start. The best place to look at for inspiration is inside oneself. What one finds to be comfortable and enjoy doing is what one must do. Starting a sole proprietorship is like building a career, you must love what you want to get into and do it for the right reasons. If food is what you love, you could start making food from your home. For those who like to write, they could become freelance writers.
Register the name of your business
Although it is not mandatory for a sole proprietorship to get registered, it would do the business a lot of good. The problem with many sole proprietors is that they don’t consider the future of the business. Any business can get a major boost and rise to unprecedented heights but looking at the current situation could hinder progress. One must register a sole proprietorship in its infancy because the name and every other peculiar detail about the business could be lost to others. By law, the one who registers a business’s name first has a right to it whether it opened 5 seconds prior or 5 decades ago. Even if a sole proprietor is not ready to expand their business, they should at least register the name.
Get a license
Not all businesses require having a license but for those that need one, their proprietors must get a license to start them. For some businesses that require a certain level of proficiency that’s standard practice in the industry, a license is vital. Before anyone starts a new business, he or she must find out if there is a need to have a license so that they can move towards securing one.
Secure the vital permits
There are different laws for setting up a business, especially a “brick and mortar”, in various regions. To set up such businesses, one must have permits. Permits can pertain to zoning where only those with certain permits are allowed to do business in a particular area. These permits will only be issued to those who have proven themselves to be capable of maintaining a credible business. A fresh sole proprietor must make findings to be sure of what it takes to get a permit.
Get a business bank account
A sole proprietorship is fairly risky seeing that whatever happens to your business directly affects you. To avoid trouble, one would need to find a way to separate one’s personal funds from his or her company’s. Doing this will help a business owner get some discipline and avoid needless or uncontrolled spending. Even though a sole proprietorship and its owner are considered the same entity, this move will help the business owner make better financial decisions. Also, it would make a sole proprietor seem more professional when clients have to make transactions in the business’s name. Open a bank account for your business and save yourself the unwanted headache.
To avoid finding oneself in a position where one would have to start from scratch after a major setback, the business must be insured. Many things could go wrong in the course of doing business and these could ruin it. It is very easy for sole proprietorships to fold as they are also easy to start. However, sole proprietorships get so successful that their owners start contemplating an expansion. A major hit could make such a business crumble, which is why one needs to insure their business. With an insured sole proprietorship comes peace of mind; it’s what every business needs.
Switching to an LLC
Every serious business person must have it in mind to convert their business from a sole proprietorship to a limited liability company or its equivalent. Even though sole proprietorships have their advantages, LLCs have more. The huge privilege an LLC has over a sole proprietorship is that a business owner and the business are regarded as separate entities.
A sole proprietorship is very limited compared to an LLC and there are opportunities that a sole proprietorship would easily lose. Converting a sole proprietorship to an LLC is what a smalltime freelancer needs to start their agency. Anyone who wants to take their business to the next level must take these following steps.
Confirm your business name
A lot of sole proprietorships are not registered and this could bring about disappointment upon confirming their business name. Since every LLC has to be registered, you must start by registering your name with the government. You’ll need to confirm that your business name has not been registered by some other business before proceeding.
Open a business account
Even though it is advised that even sole proprietorships should get a separate business account, many don’t. You must open business accounts for your LLC. These accounts include websites, social media, and bank accounts. They must all be different from your personal accounts.
You’ll have lots of paperwork to do
Switching from a sole proprietorship to an LLC will make you do a lot of paperwork and they’ll mostly be about the details of your business. You must have a clear blueprint of what your business must look like and have every detail laid out. These details include the business plan, business address, owner’s information, bank account information among others.
Register your business with the IRS
One might escape registering their business with the Inland Revenue Service while operating a sole proprietorship but not in an LLC. This conversion will bring the IRS into the conversation as you’ll start operating your business per the IRS’s requirements.
Publish your new LLC name
Changing your business form is a big deal; it’s more like being “born again” in the business world. There’s a big difference and there should be a way of making the switch public. The rules are different across regions but if you must, have the conversion made public in a news publication and present it as evidence. Your business licensing may depend on this act.
Conclusion
A sole proprietorship is so easy to start that many establish one without even thinking. The goal of every ambitious entrepreneur is to grow their business to compete with the very best. To compete, a switch to LLC will be the eventual solution. Don’t think too far into the future and start that small sole proprietorship already!