When an individual decides to start a business, they have hundreds of decisions to make. They have to decide the scale of their business, the location, and many more. One very important decision that they have to take is with regards to the ownership of their firm. There are various options to choose from. One of them is sole proprietorship. Like all other options for all questions in the world, it has its own advantages and disadvantages.
WHAT IS SOLE PROPRIETORSHIP?
Sole proprietorship is the oldest and most common form of business ownership. Its name is pretty self-explanatory. sole+proprietorship. “Self” implies one’s own and “proprietorship” implies ownership. A sole proprietorship is a business entity that is fully owned by one person. This individual owner is known as a “sole proprietor”. In legal terms, the business is not a separate entity. In the eyes of the law, the owner and the business are the same. There is no legal mandate to get a sole proprietorship registered.
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It is the simplest form of ownership. Hence, it is also the ideal choice for small or medium scale businesses. Furthermore, it is the easiest type of business to establish or take apart, due to a lack of government regulation. These businesses can operate under just the name of its owner. Additionally, they can also operate under a fictitious name, if they wish to do so. However, this fictitious name would not create a legal entity separate from the owner, it is just a trade name.
Although it is considered to be a one-person show, the proprietor can employ other people. They just cannot be part owners of the business.
A sole proprietorship is also known as the sole trader, individual entrepreneurship or proprietorship.
Advantages of Sole Proprietorship
Ease of Formation
Beginning a sole proprietorship is easy. Other business structures require a great degree of paper work to set things in motion. As there are multiple stakeholders involved, their terms of ownership and association have to be documented.
Whereas, in a sole proprietorship, a single person holds the right to ownership. Due to this reason, the amount of paperwork and formal liabilities are largely limited.
It is cheap to start a sole proprietorship. Other business structures might require heavy investment to set shop and to hire people to work. In addition, fees and filings required to start working are also high for other business establishments.
In comparison, a sole proprietorship does not involve these additional expenses and is hence a relatively cheap method of working.
There are some tax benefits for a sole proprietorship. Instead of the business having to file its own tax return, sole proprietors claim businesses gains and losses on their own individual tax return. Also, the sole proprietorship is taxed using individual income tax rates rather than corporate making it simpler and cheaper to comply with your tax obligations.
This is a huge benefit because corporate taxes are the major chunk of expenditure for any organization. Not having to pay taxes as a corporation, while enjoying relatively low taxes compared to other establishments provides a huge boost to its business model.
Ease of Employment
Sole proprietors can employ others and grow their business. Sole proprietorships can hire others and enjoy the tax benefits from doing so.
They also have an added advantage. The spouses of the sole proprietor can work for the proprietorship without even being declared as an employee. This has multiple benefits as it allows the organization to employ more people while also maintain the requisite number of employees to be classified as a small business in official work.
Easy Decision Making
Owners have complete and direct control over all decision making. Because the owner is the business, the owner makes all decisions for the business rather than sharing power with a partner or corporate board. This allows owners the freedom to drive the business in the direction they desire.
Contrast this with other forms of corporate organization like a company or a partnership. There, the express consent of everyone is required before going forward with any decision. This might hinder the chances of the business to capitalize on any business opportunity and it might lose out to its competitors. Thus, if the proprietor is someone who is not averse to taking risks, they can take the business to new heights.
Disadvantages of Individual Proprietorship
Since it is just one person involved in the managerial function of the business, there is only one person who can provide capital. This means that it is not easy to collect a large amount of capital to start and run the company. It is far easier to do so for a partnership or joint-stock company because there are multiple investors who are ready to provide funds as and when needed. The sole proprietor might be able to start the business with a limited amount of funds, but it is difficult to keep the company running without additional capital. The capacity for expanding business operations is limited because of lack of resources, even when there is a scope for expansion. Other forms of ownership are better than the sole proprietor for raising financial resources.
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More often not, sole traders rely on their personal loans and money to keep the company up and running. Thus, even getting loans is not a viable option because a single individual only has a limited amount of assets to offer as collateral.
Lack of Expertise
In a sole proprietorship, there is only one person looking after all aspects of the business. It is not possible for them to have expert knowledge of all tasks. They might be really good at handling some problems, but be absolutely clueless in the face of others. In this case, they would have to hire people look after certain aspects of the business. There is a huge difference in the way that an employee thinks of a business and how an owner does. The employee only does the jobs they are asked to do because of the money. They have no personal stake in the business. Hence, they fulfil the minimum requirement. Additionally, it is there is a lack of funds in a sole proprietorship. That also makes it difficult to hire people.
Your small business, in the form of a sole proprietorship, is personally liable for all debts and actions of the company. Unlike a corporation or an LLC, your business doesn’t exist as a separate legal entity. Therefore, all of your personal wealth and assets are linked to the business.
Unlike a partnership, where you only have to pay debts to the extent of your paid-up capital in the organization, in a sole proprietorship, your personal assets can be confiscated in case the business fails to pay back its debts.
Lack Of Financial Controls
The looser structure of a proprietorship won’t require financial statements and maintaining company minutes as a corporation. The lack of accounting controls can result in the owner being lax about financial matters, perhaps falling behind in payments or not getting paid on time. It can be a serious issue if financial controls are not strictly managed.
In other forms of business organization, as the financial returns have to be filed on a timely basis, the prudence is also there. This might be found lacking in sole proprietorships. In the long run, this can have devastating consequences.
Pros and Cons of Sole Proprietorship
|Ease of formation||
|Lack of expertise|
Ease of employment
Lack of financial controls
Easy decision making