Sole Proprietorship – Definition, Advantages, Examples, Features
Do you know which one is the oldest form of business organization? Well, it is none other than a sole proprietorship. Also, it is considered as the most common type of business structure that is found in India. Even all the businesses as you can see around you such as the grocer, the doctor, the chemist, and the shopkeeper are all types of sole proprietors. Let us know more about the sole proprietorship below to get an understanding of it.
Also See: International Entrepreneurship
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Table of Contents
Sole Proprietorship: Definition, Features, Advantages, Example
Let us begin with Sole Proprietorship.
What is a Sole Proprietorship?
As the name implies, “Sole” implies “only one” and “Proprietorship” refers to ownership. In simple words, a sole proprietorship can be explained as the type of business structure or an organization or a business that is fully owned, operated and controlled by a single person who is the sole beneficiary for all sorts of profits or losses and responsible for all risk types. It is a reliable business type that is good to start a small business, especially in the initial years of its operation. These business types are usually a specialized service like beauty parlors, small retails shops, or hair salons.
Put merely, this is a one-man organization that manages all operations alone. There is no sperate legal entity as the business and the person is the same. Additionally, a sole proprietorship needs not to be incorporated or get registered. Therefore, it is the simplest business form and the perfect choice to operate businesses from small to medium size.
The legal status of a sole proprietorship can be explained as below:
- It has no separate legal entity from the entrepreneur.
- The owner has unlimited liability.
- It can only be sued on the name of the owner.
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Definitions of Sole Proprietorship
Here is the definition of the sole proprietorship as given below.
“A sole proprietorship, also known as the sole trader, individual entrepreneurship or proprietorship, is a type of enterprise that is owned and run by one person and in which there is no legal distinction between the owner and the business entity. A sole trader does not necessarily work ‘alone’—the sole trader can employ other people.”
Exemplify: Sole Proprietorship
Most of the small to medium-scale businesses begin as a sole proprietorship but as the company grows and expands, it ends up with some different kind of business structure with the time. Let us take an example to understand it better.
In 2005, Kate Schade founded a company, named Kate’s Real Food which is a sole proprietorship. The company sells energy bars and commenced as a local vendor in a small town. In the beginning, the company sells these energy bars to the local farmers but as time passes, it expanded it to an online store and some other accounts in other nearby towns. With time, the business grows and started to sell their items across the nation and restructured the business.
With this example, we get to know what exactly a sole proprietorship is and how it works. Even it can also be taken as a starting point of the business and when it expands, then the structure will also expand if the owner wants to do so.
How sole proprietorships work?
The highlighted feature of a sole proprietorship is that there is no legal separation of the business with that of its owner unlike in partnerships and incorporated business. The business is acted as an extension of the owner and the person is solely responsible for the payment of all debts and liabilities incurred by the business as well as enjoy the profits and incentives too.
Features of Sole Proprietorship
Here are some of the features related to sole proprietorship which we have mentioned below.
- No Legal Formalities
There is no separate law-related with a sole proprietorship to govern it and thus, there is no existence of any set of special rules as well as regulations to follow. Moreover, the best part is that it does not need either any registration or incorporation of any type. In most of the cases, we require only the license to start up the desired business. As similar to that of the commencement, there are no legal operations attached to the closing procedures. So, it provides easiness to begin a business and do it with less hassle.
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As there is no separation between the business and the entrepreneur, thus the personal liability of the business owner is unlimited. If the business is not able to pay its debts and liabilities, then the business owner is accountable for the same and pay them. For instance, the owner needs to pay the pending amount either by selling their assets or property such as a house, care, and others.
- Risk and Profit
The owner of this business is the risk bearer in a sole proprietary. Since the entrepreneur is the only person who invested in the business financially, so all risks belong to him only. Whether the business fails or grows, the owner is the person who gets affected by the same. On the contrary, he also enjoys all profits earned from the business. There is no need to divide and share profits with stakeholders as there is no existence. Thus, he bears all risks and earns profits too.
- No separate legal identity
In legal terms, the business and the owner are not treated separately as both are the one and same thing. No separate legal entity belongs to a sole proprietor and the owner is wholly and solely responsible for all business activities and transactions.
As we all know that the business and the owner have the same identity. So, a sole proprietorship has entirely relied on the business owner. Some factors affect a sole proprietorship such as retirement, insanity, bankruptcy, death, and imprisonment. In such a situation, the sole proprietorship puts to an end.
As all the business operations and responsibilities lie with the sole proprietor, so he controls all the business solely. No other person can partake in business activities and the owner can modify or expand the business as per their comfort and plans.
These are all features of a sole proprietorship that will explain what exactly the business structure and how it runs. Let us take a peek at the advantages of opting for a sole proprietorship that we will jot down below.
Advantages of Sole Proprietorship
Here are some of the popular advantages attached to a sole proprietorship which we are mentioning below. Let us begin.
- Quick Decision Making
A sole business owner is liberal to take all kinds of business-related decisions as there is no need to consult with any partner or stakeholder. So. You can take prompt decisions as there is no need to get any sort of permission from anyone. There is no other person involved and he is the sole investor who has invested in the business.
Being the sole owner of the business, the information of all activities and processes is in the hands of the person only. So, this info is less likely to leak and will be private as well as confidential. He tries to keep all the business-related details and important information secure as he needs to take all the decisions of the business and how it works.
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- Direct Incentive
A profit is a kind of reward that is the result of the risk taken by the business owner. All gains earned from the business belongs to a sole proprietor only. Whether it is profit and some incentive emerged from the business, everything belongs to the sole owner only. He or she deserves to be part of all business profits and get incentives too.
- Sense of Achievement
The owner can take all decisions by himself or herself. So, when the business accomplishes something, then it gives a sense of satisfaction to the owner. With no guidance, a person is achieving all the desired things as expected. Any small piece of success gives a feeling of goal accomplishment and the owner gets motivated.
- Easy Commencement and Closure
A single-owner gets entered into this type of business structure with no and minimum legal formalities. Alike, in the end, the process of closure is too easy and simple whenever a person wants to pat an end. There are no lengthy steps of procedures involved in the formation and closure of a sole proprietorship.
All these are some positive aspects of a sole proprietorship that an owner can enjoy the most. Let us have a look at the limitations of a sole proprietorship below to know what one can suffer.
Limitations of a Sole Proprietorship
Some of the primary limitations attached to sole proprietorship have been given below.
- Limited resources
The resources invested in the business are limited as it may be taken mostly from the relatives and friends in the form of borrowing and sometimes, savings too. Banks hesitate to provide them long-term loans because of the small-scale business and weak financial background. Lack of monetary resources becomes a hindrance to the growth of the business and due to these, the business will remain small.
- Business life concerns
The owner and the business share the same entity and because of no successor, the life of the business is restricted to a short period. Because of the death, illness, or insolvency of the business owner, the business may put to an end and not able to move further for a long period.
- Unlimited liability
The owner has unlimited liability and this one is the main demerit of a sole proprietorship. Due to the business failure or loss, if the owner fails to pay any debt or liability, then the creditors have the right to claim from business assets as well as personal property. It is risky to take a huge amount of loan as it put a burden on the business owner. This is the reason due to which a sole proprietor is not able to take the risk for the growth as well as the survival of the business.
- Limited Managerial Ability
A sole proprietor has to take all sorts of responsibilities to run a business. Sometimes, the owner needs to perform some tasks such as sales, buying, marketing, dealing with all clients, and so on. He may not able to appoint aspiring and desirable employees.
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Types of Sole Proprietorship
There are three types of sole proprietorships that we have given below.
- Independent Contractors
This is the self-employed person who takes some projects from the clients. They are liberal to choose which clients are suitable for them but they need to work according to the methods and processes that the respective client needs.
- Business owner
They are the self-employed sole proprietors but they hold more autonomy in which way they work is finished for clients and the processes may even a bit complex with employees and intellectual property.
They are sole proprietors. These can get inspiration from the brand, business model, guidance, and so on in exchange for royalties as we have paid to the franchisor.
Starting a Sole Proprietorship
It is simple and easy to establish a sole proprietorship but still, it needs a person to follow some steps required to commence a great business from the initial stage. Let us begin with the same below.
- Business type you’ll begin
As it is free and easy to set up, so people prefer to turn their hustles into something simple and more profitable. A wide range of businesses is operated as sole proprietorships. Some of them include web developer, virtual assistant, IT consultant, digital marketer, Freelance graphic designer, daycare operator, fitness instructor. Housekeeper, branding specialist, Caterer, computer specialist, direct salesperson, and so on.
- Make sure sole proprietorship is good for you
The key to a venture success is to pick up the right type of business structure. The business structure that you’re opting for has a great impact on your daily operations, taxes, and what risks you’re taking for your assets. There are just a few ways available that are helpful to structure your business such as sole proprietorship, partnership, LLCs, corporations, and cooperatives. While a sole proprietorship and LLCs are the most common structures with a few differences. Consider the pros of sole proprietorship below to decide which one is better:
- Full authority for decisions
- Easy to establish
- Simple tax filing
- No cost to start
- No Balance sheet is required.
- Low rates for taxes.
Based on these aspects, decide what matters the most for you and choose the right one.
- Choose a business name
It is a fun part when it comes to choosing the name for your business and researching whether it has already taken or available for you. After selecting a name for your business, get it trademarked as no one will not claim on your chosen business name.
- Register your DBA
Being a sole proprietor, the business is running on your name and if you want it labeled with another name, then go for “doing business as” to register your business. It is also known as DBA. Most cases require you to distinguish between the personal funds and business. A DBA is necessary while opening a bank account for the business. You may also need some follow-up steps for registration. A DBA makes sure that no one else will do business at the same business name in the nation.
- Buy a domain
Once you have done with the choice of your business name, then it is time to get a domain. To keep a balance with your business, you need to make sure that the domain name includes the name of the business too. If you are not ready to build a website, then you should reserve or purchase a domain name as no one else will not take it in the future.
- Business licenses
A sole proprietorship requires a license to run the business in some cities. Do not try to skimp here as it may lead to fines if you have no license to do so. The charges can be steep. While opening a bank account for business, you need a license too.
- Keep an eye over other licenses and permits
The fees amount attached to the right type of licenses and permits can be crippling to a new start-up. Check out any licenses and permits that may be needed for your business. This may include the following:
- A health department permits if the business is related to food.
- A license for transporting animals.
- A certification to become a financial advisor.
- A zoning permit to operate a business from home.
Do the legwork and find out the suitable permits, if any required for operating your business. Otherwise, consequences can come in the form of fines that are nothing in comparison with the permit fees.
- Get an EIN
If you are working alone with the business, then there is no need to take any Employee Identification Number. But it is required in case you are planning to employ a person who will help you in the business. You must file an EIN if you are planning for retirement or want to hire an employee.
- Open a business account
It is vital to keep all personal and business expenses different when running a sole proprietorship. Opening a business bank account make sure that you have a certain level of protection for business funds that enable you to pay with a credit card and also, make cheques that are payable to the business and build a good credit history.
- Get Insurance
The main risks attached with a sole proprietorship are the liability risk that lowers the burden and having insurance is mandatory to minimize the risk. Opting for the one from property and liability coverage, health coverage, disability coverage, and auto insurance. This can be a bit steep but it ensures the safety of the personal assets against any lawsuits as well as professional setbacks that may arise.
What to consider when deciding to form a Sole Proprietorship?
When a person commences a business, then it is a bit cumbersome to decide whether it is good to choose a sole proprietorship. At first, it is simple and easy to start a business with a sole proprietorship. Here are some things that you need to consider while choosing a sole proprietorship for your business. Let us take a peek at these below.
- Pros from a sole proprietorship
There is no other easy and simple business structure available other than a sole proprietorship as it is quick and free of cost to start. You are the business in case of a sole proprietorship. But if you want to name your business with some other legal name, then you can file a DBA (doing business as). It is too simple and easy on the pocket too. Even the taxes are easy too as you can take all profits and losses on own to pay individual tax returns and you do not require to file a separate return for the business.
- Cons from the sole proprietorship
There is zero liability protection and some get sick from the products and services offered by your business, then they can sue you directly. If they win, then all your assets and including money, property, and car are all theirs.
Keep these factors in mind and choose sole proprietorship over other types of business structures.
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In the end, most business people opt for a sole proprietorship despite all its loopholes as it is a simple startup founder. The business structure is suitable where the product is limited or the customers want more personalized services. A sole proprietorship suits the best where manual skills are needed and where the requirement for capital investment is low and does not have a huge risk degree.