Building a small business requires a solid foundation of thoughtful preparation and planning. There’s no one-size-fits-all approach to achieving success, but choosing a business structure is among the many important decisions a small business owner will make, with repercussions related to risk, growth, and ease inherent in each choice.
One of the most common paths to starting up a small business in the United States is through sole proprietorship—a simple, inexpensive, and quick way to begin operations.
There are drawbacks to sole proprietorship, which can be the wrong choice for those seeking greater liability protection. But for some, sole proprietorship offers a straightforward way to begin a business, with advantages including simplicity and lower startup costs.
Experts say that familiarity with the various options is essential if a small business owner opts for a sole proprietorship or another common business type, such as a limited liability company (LLC) or corporation.
“I think it’s helpful for business owners to have a basic understanding of all of the business forms,” said Anne Hlavacka, director of the Small Business Development Center at the University of Wisconsin-La Crosse. That way, owners can make informed decisions about their business while also preparing to encounter and engage with others, she said.
Here’s what to know about sole proprietorship as you begin—or continue along—on your business journey:
What is a sole proprietorship?
A sole proprietorship may be a popular option for freelancers, entrepreneurs who want to kickstart a business without much paperwork, or those hoping to avoid additional startup costs. A sole proprietorship can be a way to get serious about a side hustle—or an option for someone working seasonally whose work involves minimal risk.
A sole proprietorship can be viewed as a flexible option for those who want to feel out a business model, said Steven Wiser, a director of the business law clinic at the DePaul University College of Law. That desired flexibility may be the case as someone considers a career change, as many did during the Great Resignation.
And, in the case of a sole proprietorship, “the barriers to entry are minimal,” Wiser said.
A sole proprietorship offers control and freedom for business owners, but because there isn’t a clear division between the owner and the business, individuals who choose this option can be held personally liable for business activity.
A quick start: sole proprietorship offers ease
When a potential small business owner imagines kickstarting operations, a daunting image of mounting paperwork might come to mind.
A sole proprietorship allows small business owners to begin a business without taking formal legal action through the state. There’s no need to form a board of directors. A business banking account isn’t required.
“It can be good for ease of operation,” Hlavacka said about a sole proprietorship. “But it depends on the situation.”
There are still critical early steps to take, such as obtaining any required licenses and government permits related to your business. Insurance can also be a vital addition to reducing risk, depending on the industry.
“To limit risk is to think things through and do things a careful, prudent person would do,” Hlavacka said.
Fewer fees: sole proprietorship can be cost effective
Generally, sole proprietorship involves fewer startup costs than forming an LLC or corporation.
Along with startup costs, there are generally annual fees associated with legal entities. And additional tax expertise may be needed and come at an additional cost.
Although sole proprietorship allows owners to avoid administrative costs, they may need to consider public notice requirements applicable when a business has a name other than the owner. This could involve registering a DBA, or “Doing Business as” name, and come with a moderate fee.
Less paperwork: sole proprietorship simplifies taxes
Considering additional tax filings for a small business may feel overwhelming, but the process can be relatively painless with a sole proprietorship.
Because there’s no formal legal separation between the owner and the business, business income isn’t taxed separately. The owner of a sole proprietorship has business results “pass through” to their personal tax return and generally files a Schedule C, which shows revenue and costs, with a personal 1040 return.
Sole proprietorship keeps filing to a minimum—along with tax complications.
How does a sole proprietorship compare to other business structures?
A significant difference between a sole proprietorship and other legal entities is the personal risk involved.
A sole proprietorship can also pose challenges as owners seek to grow their businesses. Financing may be difficult without building a business credit history and the legitimacy of incorporation. And although a sole proprietorship can employ workers, that introduces more paperwork and regulatory measures to comply with—and potentially a lot more liability.
There are additional options for owners seeking some of the qualities associated with sole proprietorship. A single-member LLC is possible to form with a single owner and can provide “pass-through” tax options while also providing liability protection.
Experts recommend taking time to choose the structure best aligned with your concerns and goals.
“The answer is there isn’t one that’s perfect for all businesses,” he said. “It’s definitely situational.”