Names like Sears, eBay, and JC Penney bring to mind millions of dollars in sales and lasting brand recognition, but they all have something else in common—they started as sole proprietorships. As the most simplistic business structure, sole proprietorships are easy to establish and inexpensive to create. But how beneficial are they in the long-term, and how do you know if you’re suited to the limitless freedom, yet high personal liability, associated with sole proprietorships?
Here, we look at the advantages and disadvantages of sole proprietorships, how they work, and who they best serve.
What is a sole proprietorship?
A sole proprietorship is a business structure linking the owner of a business to their company. It is the simplest type of business structure and not a legal entity. Sole proprietorships don’t require federal registration to operate, and the owner of a sole proprietorship is personally liable for the business’s debts.
Companies structured as sole proprietorships can include individual freelancers, creatives, growing startups, and established businesses with physical storefronts or workspaces. There is no limit to the number of people a sole proprietor can hire, though the owner is personally liable for the wages, taxes, and health and safety of employees.
A note about taxes under a sole proprietorship
Because sole proprietorships are linked to the owner as an individual, all taxes are considered a pass-through entity. This means you must declare any income or losses accrued by the business on your personal tax return, and you’ll also have to pay self employment taxes to cover contributions to Social Security and Medicare.
Advantages of a sole proprietorship
There are many advantages to operating a sole proprietorship. Here are some of the most pertinent benefits of sole proprietorship for new business owners.
Sole proprietorships are easy to establish
Sole proprietorships are inexpensive and easy to form. As long as you’re the owner and in charge of operations, there’s no need to formally register your business or notify federal or state offices. The only fees involved are those needed to register your business name, and to attain the appropriate licenses and permits.
The necessary licenses will vary according to your industry and operations, with certain licenses required to handle food and alcohol, operate a storefront and put up a sign, or run a business from your home. Other than these requirements, starting a sole proprietorship happens inadvertently when you’re working as a contractor or freelancer and trading under your personal name.
The ability to operate as a sole proprietor, without formal registration or high costs, is especially beneficial if you’re building your startup as a side gig, outside your regular day job. The ease of establishment means you don’t have to be 100 percent committed or invested financially to begin operations.
“Most people say that you must be fully dedicated to your project in order to make it work, but it is definitely possible to start without leaving your day job,” says Yael Oppenheim, founder of FitMyTime, which connects fitness trainers with customers online, to Ideas by WeWork. “The best solution, in my opinion, is to work part-time to sustain yourself for several months while developing your idea.”
You can protect the name of your sole proprietorship
As a sole proprietor, the legal name of your business is your personal name. If you wish to change this, and operate your business under a different name, there are two ways to move forward. First, you can register a trademark through the U.S. Patent and Trademark Office website. The process typically takes around 90 minutes and doesn’t require a lawyer. (It’s a good idea to check the Trademark Electronic Search System ahead of time to ensure there isn’t another company already registered under your desired name.)
Alternatively, you can file a Doing Business As (DBA) with your state or county clerk’s office, which allows you to operate a business under a name that’s different than your own. This involves completing the appropriate paperwork and paying a filing fee. Processing times vary between states, and DBAs typically expire after several years. It’s important to refile your DBA before this expiration date, and also if you change your address or your legal name.
What’s the difference between trademarks and DBAs, in practice? Trademarks exist to grant exclusivity to the business owner, helping them differentiate their product or service from their competition. Alternatively, a DBA is nonexclusive (there can be multiple businesses under the same name) and exists to protect the public by providing a record of the person behind the business in question.
There’s no limit to the number of people you can hire
There is no limit to the number of people you can employ as a sole proprietor, and this allows you to grow your reach and your team without taking the leap to formally incorporating your business.
There are risks associated with this; as the owner of a sole proprietorship, you are personally liable for the well-being and payment of your employees (more on this below). However, when you’re fighting to get your business off the ground, the freedom to hire top talent as soon as you can—whenever they’re available and without any adjustments to your business structure—is highly advantageous. Often, these collaborators can emerge unexpectedly and help you in ways you may not have considered.
“Once you’ve made the leap [to starting your own business], it’s amazing how resourceful you become,” says Kirk Reynolds, founder and president of guide company Discover Outdoors, to Ideas by WeWork. “You’ll find there are people who want to help you, so you won’t be alone. Also, don’t wait until you have everything perfectly planned. That day will never come.”
You have complete control as the owner
Sole proprietorships are automatically tied to you personally, and this gives you complete control over the company and its trajectory. There is no need to make decisions based on the wants of shareholders or the requirements of legal partners. You can pivot your strategy as needed, and take your startup in any direction you wish to grow.
This freedom means sole proprietorships are a popular first-step in building a business, as the structure gives owners the flexibility to experiment before committing to the regulations involved in operating a Limited Liability Company (LLC) or a corporation.
Sushi delivery restaurant Zoku Sushi, for example, began operations in São Paulo, Brazil, with a small-scale test market. This starting point allowed the company’s founder, Charlie Yi, to test the concept and build the necessary technology before launching a delivery-only restaurant in New York. This level of testing—at any location, with any iteration of your product—is easier with a sole proprietorship compared to other business structures that require formal registration with local government.
Sole proprietorships are often a stepping stone to incorporation
Before it became eBay, the online trading platform was a sole proprietorship owned by Pierre Omidyar and operated under the business name Auction Web. Before changing the name to eBay in 1997 and then incorporating the business, the company had already sold more than one million items, and several employees were hired at the start of what today is known as the “eBay campus.”
Arguably, none of this would have happened if Omidyar hadn’t been able to start operations as a sole proprietor from his living room in San Jose, California. And sole proprietorships are commonly used by entrepreneurs as a stepping stone to opening an LLC or a corporation.
Disadvantages of a sole proprietorship
As with any business structure, there are disadvantages to sole proprietorships as well. Here, we look into the two biggest risks—liability and difficulty raising capital.
The same way sole proprietorships afford you the freedom to operate as you see fit—adhering only to licensing mandates without registration or shareholders—this freedom comes with responsibility. As a sole proprietor, you are personally liable for paying contractors, honoring debts, paying the necessary taxes and insurance for your employees, and any legal contingencies.
If your sole proprietorship is sued for malpractice or bankruptcy, for example, your personal assets including your home, cars, and bank accounts can be seized to cover these expenses. This differs from other business structures, in which a business is legally separated from its owner and there’s no risk to personal assets if an employee is injured, the company is sued, or debts aren’t repaid.
Even if you’re an individual freelancer, it’s important to be aware of self-employment taxes that must be paid to cover Social Security and Medicare.
Difficulty raising money
The personal liability of a sole proprietor represents risk and, for this reason, banks can be hesitant to lend money or issue credit under this business structure. It’s also more difficult as a sole proprietor to generate buy-in from investors, as the company is not formally recognized and is not designated to have shareholders.
Consider alternative financing options, like bootstrapping and crowdfunding, at the outset. Bootstrapping a business is relying on personal savings or company sales for funding, rather than outside investors. Crowdfunding, on the other hand, is financing a business through many small donations or investments through a platform like Kickstarter or Indiegogo. Adriana Vazquez did market research before launching a Kickstarter for her company Lilu, which makes an innovative breast pumping bra.
“Before we started Lilu, we sent out a survey to a handful of moms with a few questions about pumping equipment and products,” Vazquez told Ideas by WeWork. Vazquez raised $33,377 for her first run of bras on Kickstarter.
“The next morning, we had more than 500 responses from moms with one particular gripe: Breast pumping sucks—and we realized it was worth investing time and effort into redesigning that experience,” said Vazquez. “A crowdfunding campaign was an option because we knew that there was a strong community of people who wanted to see change in this space.”
A growing business needs the right business structure
With so much to consider in building a business—including writing a business plan, raising capital, staying inspired, and knowing when to invest full-time in your startup dream—the ease of sole proprietorship can feel like a relief. You can begin work without formal registration, and there are minimal upfront costs involved in securing your business name and the appropriate licenses.
Yet be sure to do your homework when you begin to take advantage of the ease of launching a sole proprietorship. Eiko Nakazawa, the founder of early childhood education startup Dearest.io, began her company as a side project while she conducted research and small-scale tests over four months. “Talk to other founders with similar business models, as well as people in your industry and investors,” she told Ideas by WeWork. “If you are open about what you’re working on and are able to reach out to many people, you should be able to get relevant feedback and advice. Not only are these helpful for you to plan the next steps, but also useful for you to understand potential pitfalls and challenges.”
As you move through the startup phase, coworking spaces like WeWork can also provide support, giving you access to a global community of business leaders and offering flexible monthly leasing agreements. Meeting collaborators and building brand recognition happens naturally in WeWork spaces, and the ability to host meetings (or your own events) in beautifully designed workspaces is key to wooing investors and attracting new clients.
As you grow, however, it’s essential to be cognizant of the risks associated with sole proprietorships. Be sure to protect yourself and your personal assets in hiring staff or entering into debt, and consider transitioning to an LLC or corporation if the potential toll becomes too high.
Until then, take advantage of the freedom, ease, and affordability of the sole proprietorship structure. It’s been a formative stepping stone for many entrepreneurs previously, and can certainly provide the flexibility you need to launch your startup and set yourself up for future success.
For more tips on launching and scaling a startup, check out all our articles on Ideas by WeWork.
This article was originally published on January 10, 2020, and has been updated throughout by the editors.
Caitlin Bishop was a writer for WeWork’s Ideas by WeWork, based in New York City. Previously, she was a journalist and editor at Mamamia in Sydney, Australia, and a contributing reporter at Gotham Gazette.