Sole Proprietorships: Advantages, Disadvantages, and Structure
Sole Proprietorships
Advantages of Sole Proprietorships
A sole proprietorship is the simplest form of business ownership, offering several key benefits to the owner:
Ease and Low Cost of Formation and Dissolution
No contracts, agreements, or other legal documents are required to start a sole proprietorship. Most are established without even hiring an attorney. A sole proprietor does not pay any special start-up fees or taxes.
Retention of All Profits
All profits earned by a sole proprietorship become the personal earnings of its owner.
Flexibility in Operations
The sole owner of a business is completely free to make decisions about the firm’s operations. A sole owner can also respond to changes in market conditions much more quickly than the operators of other forms of business.
Possible Tax Advantages
The sole proprietorship’s profits are taxed as personal income of the owner. Thus, a sole proprietorship does not pay the special state and federal income taxes that corporations pay.
Business Secrecy
Sole proprietors are not required by federal or state governments to publicly reveal their business plans, profits, or other vital facts.
Disadvantages of Sole Proprietorships
While simple to establish, sole proprietorships carry significant risks and limitations:
Unlimited Liability
Unlimited liability is a legal concept that holds a sole proprietor personally responsible for all the debts of his or her business. This means there is no legal difference between the debts of the business and the debts of the proprietor.
Lack of Business Continuity
Legally, the sole proprietor is the business. If the owner dies or is declared legally incompetent, the business essentially ceases to exist. In many cases, however, the owner’s heirs take over the business and continue to operate it, especially if it is a profitable enterprise.
Limited Ability to Borrow Capital
Banks and other lenders are usually unwilling to lend large sums to sole proprietorships. Only one person – the sole proprietor – can be held responsible for repaying such loans, and the assets of most sole proprietors are fairly limited. The limited ability to borrow can keep a sole proprietorship from growing. It is the main reason why many business owners change from the sole proprietorship to some other ownership form when they need relatively large amounts of capital.
Limited Business Skills and Knowledge
Managers perform a variety of functions (including planning, organizing, and controlling) in such areas as finance, marketing, human resources management, and operations. Often the sole proprietor is also the sole manager – in addition to being a salesperson, buyer, accountant, and, on occasion, janitor. Even the most experienced business owner is unlikely to have expertise in all these areas. Consequently, the business can suffer in the areas in which the owner is less knowledgeable, unless he or she obtains the necessary expertise by hiring assistants or consultants.
Lack of Opportunity for Employees
The sole proprietor may find it hard to attract and keep competent help. Potential employees may feel that there is no room for advancement in a firm whose owner assumes all managerial responsibilities. And when those who are hired are ready to take on added responsibility, they may find that the only way to do so is to quit the sole proprietorship and either work for a larger firm or start up their own business.