Sole Proprietorship Definition
A sole proprietorship is considered one of the easiest types of businesses to start. Unlike corporations or LLC’s, you don’t have to register with the state. However, you must acquire appropriate permits and licenses to operate legally, and you are personally liable for debts, lawsuits, or taxes your company accrues.
The United States Small Business Administration reported over 70% of U.S. businesses in 2013 were owned and operated by sole proprietors or sole traders. Many entrepreneurs love sole proprietorships because of the ownership they have over business decisions and revenue and how easy and cost-effective they are to set up.
But sole proprietorships are strapped with big risks. Increased personal liability, difficulty raising capital, and a perceived lack of professionalism are a few of a pitfalls sole proprietors must navigate.
So, what’s the low-down on sole proprietorships, and how do you start one? I’ve got an easy guide for you below. Before you start a business, however, it’s important to have a business plan. Here’s an easy-to-use business plan template to begin.
Starting a Sole Proprietorship
Step 0: Decide what kind of business you’ll start
A variety of businesses are operated as sole proprietorships. Because they’re free and easy to start, many people use sole proprietorships to turn their side hustles into something a little more serious -- and lucrative. Here are some examples of common sole proprietorships:
Sole Proprietorship Examples
- Daycare operator
- Freelance graphic designer
- Freelance writer
- Fitness instructor
- Direct salesperson
- Accountant/Tax preparer
- Computer/IT specialist
- Financial planner
- Home healthcare worker
- Virtual assistant
- Event planner
Step 1: Ensure a sole proprietorship is right for you
What's a Sole Proprietor?
A sole proprietor has complete control over the revenue and operations of their business. However, the sole proprietor is also personally responsible for all debts, lawsuits, and taxes their company accrues. So, if their business is sued, personal assets like their home, credit score, and savings are unprotected.
Choosing the right business structure is key to your venture’s success. As the SBA points out, “The business structure you choose influences everything from day-to-day operations, to taxes, to how much of your personal assets are at risk.”
Sole Proprietorship vs. LLC
A limited liability corporation (LLC) provides the business owner liability protection and tax advantages, while sole proprietors bear personal liability for their business. Additionally, an LLC can be owned by investors, while a sole proprietorship is usually owned and managed by an individual.
Sole proprietorships, partnerships, limited liability companies (LLCs), corporations, and cooperatives are just a few of the ways you can structure your business. While sole proprietorships and LLCs are two of the most common business structures, there are key differences between them. Here are a few of the top benefits to starting a sole proprietorship:
Sole Proprietorship Advantages
- Full decision-making authority
- Easy to set up (No state registry necessary)
- Free to start (Other fees apply, but you won’t pay the $1000 average cost of starting an LLC)
- Simple tax filing
- Low tax rates
- Balance sheets not required by the IRS
- Full control over revenue
And here are a few of the disadvantages to structuring your business as a sole proprietorship:
Sole Proprietorship Disadvantages
- Personal assets are at risk
- Increased personal liability for lawsuits
- Business bankruptcy means personal bankruptcy
- Difficulty raising capital
- Self-employment tax
- Many banks require businesses to incorporate before they’ll lend money
- Perceived lack of professionalism
Once you’ve determined a sole proprietorship is right for you and your business, it’s time to talk to the experts.
Step 2: Talk to your nearest Small Business Development Center
Before you establish your sole proprietorship, reach out to your nearest Small Business Development Center to understand the steps your state, city, or county require in order for you to operate your business legally.
Step 3: Choose a name
Choosing a name is the fun part -- researching whether or not it’s taken and trademarked is where things can become difficult. Search the United States Patent and Trademark Office (USPTO) to learn whether your chosen name has been trademarked. If it hasn’t, consider filing your name with the USPTO to get a trademark on it, so no one else can operate under that name.
Step 4: Register your DBA
As a sole proprietor, the legal name of your business is your personal name. However, if you want to operate under a different name, say, “Global Business Consulting Services,” you’d want to register a fictitious or “doing business as” name, also known as a DBA.
In many cases, you’re required to separate business and personal funds. A DBA is often necessary when opening a bank account or credit card for your business. Your state might also require follow-up steps after registration.
Most commonly, you’ll be required to publish the name you’ll be doing business under publicly -- and then provide proof of publication to your local government.
A DBA also ensured no one else in your county is doing business under the same name. Bottom line? Register your DBA and do it soon.
Step 5: Purchase a domain
Once you’ve picked the perfect name, it’s time to go after a domain. For an easy client experience, your domain name should be the same as your business. Search to see if the domain you want is taken using these SBA-accredited databases. Even if you’re not ready to build the website, reserve or buy your domain name so no one else can.
Step 6: Register for a business license
Even sole proprietorships need a business license to operate, in most cities. Don’t skimp here. The fines on operating without a license can be steep. You might also need your business license to open a bank account -- but more on that below.
Step 7: Check on other permits or licenses
The fees associated with not have the correct licenses or permits can be crippling to a young business. Check here for federal licenses and permits and here for state licenses and permits. These might include:
- A health department permit for preparing or serving food
- A federal license for transporting animals
- A health and safety training for opening a daycare
- A certification exam to become a financial advisor
- A zoning permit to operate your business from home
- Registration with the state tax authority if you have employees or collect sales tax
Do the legwork up front and find out what licenses and permits you need. The fees you’ll pay during this process are nothing compared to the fines you’ll pay if you haven’t filed the right paperwork.
Step 8: Get an employee identification number (EIN)
If you operate alone, you might not need an employee EIN and can operate and file taxes under your social security number. As soon as you hire an employee or set up a retirement plan, however, you must file for a federal employer identification number (EIN). Its free and can be obtained online.
Step 9: Open a business bank account
It’s important to keep personal and business expenses separate when running a sole proprietorship (especially if you get audited). Opening a business bank account ensures a certain level of protection for your business funds, allows customers to pay with a credit card and make checks payable to your business, and allows your business to build a good credit history.
You want to be able to prove to the IRS you’re running your business to make a profit. This ensures the losses you experience during the first few years will remain tax deductible.
It’s also wise to build good credit history before actually starting your business. While credit cards can help you out in your company’s early days when cash flow is low, the interest adds up quickly and can easily become overwhelming.
A personal loan is often a better option, and good credit history is necessary for securing a loan of this type.
Step 10: Load up on insurance
Because one of the biggest risks to starting a sole proprietorship is the liability it burdens the owner with, having adequate insurance is a must.
Consider property and liability coverage, auto insurance, health coverage, and disability coverage, at the very least. This can get expensive, but it ensures you and your personal assets are protected from lawsuits and professional setbacks, should they arise.
Check out this SBA article to learn more about the coverage you need.
Step 11: Pay your taxes
As a sole proprietor, you’ll pay income tax on all income your business nets. File your sole proprietorship incomes taxes by using Schedule C on your Form 1040 and adding the income or losses your business incurred to the other income you record.
You can use any business losses to offset other sources of income, like a salary from your day job or a spouse. But be careful not to step into “hobby business” territory with the IRS. You must prove your business is not a hobby in order to lower your taxes. When your business becomes profitable, it might be time to file for corporate status or become an S corporation.
Remember, because you’re self-employed, your paychecks don’t have proper withholdings taken out at the time you’re paid. Instead, you can expect to pay quarterly estimated tax payments, and cover the difference or receive a refund for any shortage or overage come tax season.
Because of this, you should be setting aside money from each paycheck to cover those quarterly and annual expenses.
Starting a business is one of the biggest choices you’ll ever make. Build a strong foundation to ensure lasting success. And check out our Ultimate Guide to Entrepreneurship to make sure you have the tools you need.
Originally published Sep 19, 2018 7:30:00 AM, updated October 30 2019