One of the most straightforward business formations in the U.S. is the sole proprietorship. It requires no registration or filing fees, and the IRS treats it as a pass-through entity, allowing owners to file their taxes as individuals. This flexibility makes this structure for start-ups because of the low overhead to get started.
However, there are some disadvantages to running a sole proprietorship that should make you think twice. The legal liability of owning a company will fall entirely on your shoulders–and pocketbook. Depending on the industry you’re in, this may not be too serious of an issue, but investigate how the added risk could impact the future of your success.
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Businesses Best Suited for Sole Proprietorships
Is your company able to weather the storms that will arise in the course of business? The reality is that almost every industry has room for sole proprietorships, and determining if your venture is one of them depends on the characteristics of your operations.
Below is a brief overview of companies that would be best suited to operate as sole proprietorships based on their organizational characteristics:
Single-Owner Companies
Sole-proprietorships have no risk of partnership disputes because you can only have one owner. However, if you don’t plan to bring additional stakeholders to partner with later, then you may find this entity structure suits your goals best.
However, even if this plan changes, you can easily register your business with your Secretary of State under the entity formation you prefer. That simplicity makes sole proprietorship the most common structure to use when first opening your company.
Management Style
If you plan to maintain managerial control over your business, a sole proprietorship may be a great way to start. Because you are essentially the company, you never have to worry about takeovers or taking your control away by other stakeholders without your consent.
For example, if you own a restaurant, you might allow leadership to make decisions about hiring staff and addressing customer service issues. You may decide to continue handling inventory and equipment purchases to keep overhead in check when it comes to finances.
You won’t have this level of control in most corporations and some LLC structures because you’ll need to create and submit an Articles of Organization and Operational Agreement to your state. These documents outline how your company is run, including the processes to follow if a dispute arises between yourself and other stakeholders.
Business Perils
One of the most significant disadvantages of being a sole proprietor is that you don’t have the same asset protection as LLCs and corporations. If you owe business debts, all of your property, including your personal finances, are vulnerable to collection attempts and damage claims. This is a serious risk for new companies and requires careful planning to deal with those situations effectively so you aren’t faced with permanent closures.
Liability policies are a great way to get comprehensive insurance coverage perfectly tailored to your business risks. Many insurers offer more than just general liability, which is important since many of the threats to your business won’t involve third-party damage claims against you. If a hurricane wipes out your Miami-based jet ski rental shop, a business interruption policy can help replace your lost income while making repairs.
Professional liability coverage is essential for attorneys, hairdressers, and other skilled service providers. However, general liability insurance doesn’t cover professional mistakes, like an accountant triggering a tax audit due to an error on end-of-year revenue reports.
Other protections that insurers offer sole proprietorships include:
- Commercial auto
- Tools & Equipment
- Workers’ Compensation
- Commercial Property
- Business Owner’s Policies (BOPs)
While it’s true that your business may not need more than a general liability policy, it only takes one lawsuit to bring an end to your hard work. This is why it’s best to prepare for every scenario that could impact your company and protect your assets against it. The coverages listed above often include payment for your legal defense fees fighting these claims and can help your reputation recover more quickly.
Business Filing and Reporting
One of the most time-consuming aspects of running any business is administrative tasks. From regulation compliance to registration and state reporting requirements, associated costs add up fast.
If you want to avoid this governmental red tape, a sole proprietorship cuts right through it all. These structures impose the least legal demands on business owners, which means spending more time on growth and profitability.
Final Thoughts
When determining what business entity formation is best for your company and future financial goals, sole proprietorships are a great starting point that allows you to retain more control. However, the increased personal risk is a serious consideration and is a disadvantage you shouldn’t take lightly.
Prepare against business perils by carrying adequate commercial insurance to shoulder the financial burden that unexpected repairs, customer injury claims, and hurt employees can cause.
