Many businesses start out as sole proprietorships. In this lesson, you’ll learn what a sole proprietorship is and its advantages and disadvantages. You’ll also have a chance to reinforce your knowledge with a short quiz.
Sole Proprietorships and Small Business
Meet Beth. Beth loves books and has decided to start a used bookstore. She rents out a small retail space and starts looking for inventory.
Beth is a sole proprietor. A sole proprietorship is a form of business where there is only one owner, and there is no legal distinction between the business and the owner. Let’s look at what operating as a sole proprietor means for Beth.
Advantages of Sole Proprietorship
Operating as a sole proprietor offers some distinct advantages for Beth. It’s a pretty simple and easy type of business organization to manage. As we mentioned earlier, there is no legal distinction between her and the bookstore. Beth is her bookstore, and the bookstore is Beth. So, she doesn’t have to worry about a board of directors or shareholders. Beth is the one and only boss, answerable to no one but her customers and creditors. This also makes it easy for Beth to cash out and sell her bookstore when she wants to do so.
Beth doesn’t have to figure out and comply with complicated laws and regulations with which corporations must contend. And, she doesn’t have to file anything with the state or keep special types of organizational records, like corporate bylaws and meeting minutes. Since she doesn’t have to hire accountants and lawyers to prepare paperwork and advise her on complicated laws, she saves a bunch of money.Income taxes are also a snap compared to corporations because Beth and her business are one and the same in the eyes of the law. Beth is the only taxpayer. She simply reports her business income or loss on her personal tax return.
This also means there is no double taxation like with a corporation where the corporation is taxed on its income, and then its shareholders are taxed on dividends distributed to them from the corporation’s income.
Disadvantages of Sole Proprietorship
Beth does face some disadvantages as a sole proprietor. The biggest disadvantage for Beth is that she is completely liable for the debts and contractual obligations of her bookstore. If the bookstore doesn’t pay its bills, creditors can pursue Beth in court and satisfy any court judgment by selling Beth’s property, including things like money in her bank account, her house, car and even her furniture.She is also liable for any negligence or wrongful acts resulting from operating the bookstore. For example, if a customer slips and falls on the recently waxed floor at the store, Beth may have to pay for damages that customer suffers if a court finds the business was negligent in maintaining the floor. Beth is subject to this personal liability because the law does not recognize any difference between her actions and the actions of her business.
In contrast, if Beth owned a corporation, the corporation is considered separate from its owner, so the owners have limited liability. Not so for Beth and her bookstore. Of course, Beth can buy liability insurance.Another disadvantage is the fact that a sole proprietorship is a one-person show. A sole proprietorship can have only one owner by definition.
If Beth wants to bring in business partners, she’ll have to form a different business organization. If she and her business partner don’t do anything, the business automatically becomes a partnership. They can also form a corporation or a limited liability company.
Let’s review what we’ve learned. A sole proprietorship is a type of business characterized by one owner. The law recognizes no distinction between the business and the owner – they are one and the same.This form of business offers a businessperson some advantages. It’s relatively simple to organize and manage when compared to other business organizations, like a corporation. It also allows for one level of taxation.
Income and losses from the business are reported on the owner’s personal tax return. The owner doesn’t answer to other people, such as a board of directors or shareholders. It’s also easy for an owner to sell the business.A sole proprietorship also has some disadvantages. A sole proprietor is fully liable for the debts, contracts, wrongful acts and negligent acts resulting from her business.
Additionally, a sole proprietorship is available to use only if there is one owner. If two or more people want to share a business together, a different form of business organization must be used, such as a partnership, corporation or limited liability company.
This lesson can help you gain the skills to accomplish the tasks that follow:
- Describe what a sole proprietorship is
- Explain the advantages and disadvantages of a sole proprietorship