What is a sole proprietorship?
A sole proprietorship is a business owned by one person who is responsible for all of the business’s debts, taxes, and legal liabilities. Because it’s owned by one person, a sole proprietorship is one of the easiest types of businesses for emerging entrepreneurs to create. As a result, it is one of the most popular business types in the United States, with more than 25 million businesses registered as sole proprietorships.
Unlike corporations and LLCs, sole proprietorships do not shield their owners – known as sole proprietors – from their firm’s debts, taxes, and legal liabilities. Sole proprietorships are less expensive to set up, but also riskier to operate, increasing the need for small business insurance.
Who is a good fit for a sole proprietorship?
Sole proprietorships are most suitable for people who want to get into business quickly, with fewer legal complications and fees.
The process to create a sole proprietorship is relatively easy:
- Register your business with your state tax authority.
- Secure a business license, if required in your area.
- Set up a business checking account to deposit business income and pay expenses.
You can literally go into business as a sole proprietor in a single morning or afternoon. In contrast, establishing a corporation requires hiring a lawyer to draft articles of incorporation and other business expenses.
What are the advantages of a sole proprietorship?
There are several advantages to doing business as a sole proprietorship, including:
- It’s the easiest and cheapest type of business to start and operate.
- It doesn’t require sharing power with corporate officers or board members.
- Sole proprietors receive all business revenue personally, paying for expenses and retaining profits as they see fit.
- Unlike corporations, sole proprietorships don’t require owners to file two tax returns – one for their personal finances and one for their corporation. With sole proprietorships, owners report their business income or losses on their personal tax return.
- Owners don’t have to pay state unemployment tax on themselves.
- Owners can mix personal and business assets, although this also creates some risk.
What are the disadvantages of a sole proprietorship?
Disadvantages of sole proprietorships include:
- Sole proprietors are personally responsible for the losses, loans, and legal liabilities of the business. As a result, they can lose all their personal assets if their business fails or gets sued.
- Owners of sole proprietorships have limited opportunities to raise capital. Unlike someone who forms a corporation, a sole proprietorship can’t sell shares in the business to generate cash for buying equipment, real estate, or other business assets.
- Sole proprietors cannot collect unemployment benefits if their business fails.
- Since they’re not legally distinct from their owners, sole proprietorships have difficulty surviving the death or disability of their founders.
- Because sole proprietorships are closely bound to their owners, they can be difficult to sell. They tend to lose their value once the founder stops doing business.
What are the insurance implications?
Sole proprietors have the same legal liabilities corporations do, and they are generally eligible for protections with most small business insurance policies.
For example, if a service they perform for a client has a negative financial impact or causes property damage, the client could take legal action. In this case, professional liability or errors and omissions insurance could provide financial protection.
The difference is a sole proprietor is personally responsible for all legal judgments and settlements, unlike the owner of a corporation or LLC, whose legal structure shields against personal liability.
It’s essential for sole proprietors to have robust insurance protection to protect their personal assets.
What insurance should sole proprietors buy?
Sole proprietors should consider protecting themselves against their major risks of doing business, including:
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