What is a Sole Proprietorship?
A sole proprietorship (also known as individual entrepreneurship, sole trader, or simply proprietorship) is a type of unincorporated entity that is owned by one individual only. It is the simplest legal form of a business entity.
Note that, unlike the partnerships or corporations, a sole proprietorship does not create a separate legal entity from the owner. In other words, the identity of the owner or the sole proprietor coincides with the business entity. Because of this fact, the owner of the entity is fully liable for any and all the liabilities incurred by the business.
The simplicity of a sole proprietorship makes this form of business structure extremely popular among small businesses, freelancers, and other self-employed individuals. What begins as a sole proprietorship may be transformed into another, more complex business structure, such as a corporation, if the business grows substantially and begins hiring a sizeable number of employees.
Advantages of a Sole Proprietorship
Despite its simplicity, a sole proprietorship offers several advantages, including the following:
1. Easy and inexpensive process
The establishment of a sole proprietorship is generally an easy and inexpensive process. Certainly, the process varies depending on the country, state, or province of residence. However, in all cases, the process requires minimum or no fees, as well as very little paperwork.
2. Few government regulations
Sole proprietorships adhere to a few regulatory requirements. Unlike corporations, the entities do not need to spend time and resources on various government requirements such as financial information reporting to the general public.
3. Tax advantages
Unlike the shareholders of corporations, the owner of a sole proprietorship is taxed only once. The sole proprietor pays only the personal income tax on the profits earned by the entity. The entity itself does not have to pay income tax.
Potential disadvantages include the following:
1. Unlimited liability of the owner
Since a sole proprietorship does not create a separate legal entity, the business owner faces unlimited personal liability for all debts incurred by the entity. In other words, if a business cannot meet its financial obligations, creditors can seek repayment from the entity’s owner, who must use his or her personal assets to repay outstanding debts or other financial obligations.
2. Limitations on capital raising
Unlike partnerships and corporations, sole proprietorships generally enjoy fewer options to raise capital. For example, the owner cannot sell an equity stake to obtain new funds. In addition, the ability to obtain loans depends on the owner’s personal credit history.
Thank you for reading CFI’s guide to Sole Proprietorship. To keep learning and developing your knowledge of financial analysis, we highly recommend the additional CFI resources below: