What is a Sole Proprietorship?
For many entrepreneurs, a sole proprietorship is the first step to living the dream of being their own boss, doing what they love, and being able to do what they want, when they want.
A sole proprietorship, or as referred to as "sole trader" in the UK, is one of the most hassle-free ways to start a business. That is primarily because, unlike LLCs or corporations, a sole proprietorship does not require you to register the name of your business with the state. However, when starting a new business as a sole proprietorship, it is necessary to file for the necessary permits to run the business, obtain licenses and operate in a legal capacity. Moreover, you will 'solely' be liable for any lawsuits, personal business liabilities, taxes and accruals made by your business.
Some examples of a sole proprietorship business model
A catering company
You can start a catering operation to offer services for seminars, office events, weddings, parties and executive functions. You can spearhead everything and hire your own employees.
A landscaping business
As a landscaper, you may choose to work on your own or hire part/full-time labour. You can get big residential and commercial contracts on your own, get a team in place and start working on the projects.
Computer repair services
A majority of computer and electronic repair shops are run by sole proprietors. You can easily set up shop at your home and cater to different customers individually.
The pros & cons of sole proprietorship
1. A cost-effective and hassle-free set-up:
Since a sole trader business has a pretty straightforward business structure, you won't have to worry about any complex paperwork or comprehensive filings to get things started. All you have to do is just start operating the business. Moreover, you are not required to pay any fees pertaining to filing paperwork or incorporating your name.
However, it is important to understand that depending on the type of industry you are opening your business in, you will have to apply for a special license, a business insurance policy, permits and a surety bond. But you will not have to register the filing with your state.
2. No hassle of filing annual reports
There is also no need for a sole proprietor to file annual reports with the state. As a matter of fact, except for your annual tax returns, there isn't any other traditional paperwork you need to worry about. A sole trader set-up is vastly different from LLCs or C-corporations where the companies have to file annual reports to stay current with regards to their managers, updating the state as to changes in members and executives.
1. Unlimited liability
As the frontrunner of the company, you will be burdened with being liable for all expenses, liabilities and debts incurred by your business. There will not be any LLC or C-corporation limited liability protection covering you. You are going to have to pay out of your pocket if it comes to things like negligence or if there is any indication of business malpractice, etc.
2. No Extension of Business Life
If you are an LLC, no matter what happens to you, your business will keep on going in perpetuity. Even if you opt out of the business or pass away, the business will keep on surviving. Sure, you are going to have to stay up to date with all the paperwork, maintain your licensing and submit your annual filings. In contrast, if you are a sole trader and if something happens, your business will cease to exist.
10 steps to setting up your sole proprietorship
1. Seek advice to ensure sole proprietorship is right for your business
This is vital. A sole trader business model may seem attractive because you can be your own boss and make decisions on your own. However, if you do not know what you are doing, your operations can come to a dead stop before even lifting off the ground. You need to seek adequate and professional counsel on whether your business is best suited to a sole proprietor framework or not.
2. Choose a name for your business, and consider whether you want to use dba (doing business as)
Giving your business a name is an exciting part - however, you are going to have to try a lot harder to come up with something that is not trademarked. Go to the USPTO website (United States Patent and Trademark Office) to look for a name that is not already taken or registered.
If you find something that is not registered, you can have it trademarked right then and there. In addition, as a sole trader, the trademarked name of your business is also considered your personal name. However, if you wish to run your business in another name, you can have a fictitious business name trademarked or operated under a DBA, which is short for "Doing Business As".
3. Open a business account
It's important that you keep your business expense account and your personal account separate when operating a sole proprietor entity. This is especially true if your business gets audited. Getting a business bank account also enables you to provide your customers the opportunity to make payments with credits and debits cards or via checks.
4. Purchase a domain & web hosting service
If you are planning to operate an online or run an ecommerce business, you'll need a website. For this you'll need to purchase a domain name as well as web hosting. It would be great if your domain name is the same as your business name, but don't get too hung-up on this as it's getting increasingly difficult to get the domain name you want.
For web hosting, it's important to start on the right footing and go with a company that's reliable and can provide the assistance you need when you come across problems. SiteGround is one of the best web hosting companies I have ever worked with. Their helpline staff is very knowledgeable and has never failed to answer my questions.
5. Register with necessary government bodies
It is important to first get an EIN number (Employer Identification Number), especially if you plan to hire one or more than one employees. EIN is important as it is basically your business' Social Security.
If you've named the business after your last name or your entire name, you will not have to register it with the state. However, if you are using a fictitious business name it is important to first register it with the county or state.
In a majority of US counties or rural area, if you plan to run a sole proprietorship operation, you are going to have to register the business with the domestic tax collector. This is also true in LLCs and C-corporations.
6. Check if your work requires permits / licenses
Another important aspect of a sole trader business is getting the necessary permits and licenses to operate. Depending on the nature of your business you may require environmental licenses and vocation-based permits to operate. You will also need to ensure that your business adheres to local zoning laws to ensure public health isn't at risk.
7. Get insurance
One of the biggest risks of operating a sole proprietorship is the fact you are going to finance everything out of your own pocket, and/or ultimately be personally liable for any loans. You are not a limited liability company. So, in case anything goes wrong - for example, if there is a fire or theft, and you do not have any insurance, all those expenses are going to come out of your pocket.
So it is absolutely necessary to at least apply for liability, health, auto and disability coverage. Sure, this is going to put a toll on your bottom line, but your business will remain protected from unforeseen consequences.
8. Plan for taxes
As a sole trade entity, you are liable to pay tax on income derived from the net profit of your business. You can pay your tax via the Schedule C on the IRS 1040 Form. You can use your business losses to offset your spouse's salary or if you are earning a salary from a day job. The important thing is it is wise to set aside the necessary amount of cash to pay your taxes at end of the year. Do not procrastinate on this.
9. Write a business plan
Without a solid business plan, you cannot hope to succeed. You need a thorough framework of your business model and roadmap that shows where you will stand in the coming couple of years. Moreover, although you are the sole business owner, a business plan is required by many lending institutions should they decide to bankroll your working capital.
Consider an overview of the business model, the types of services / products you are selling, and your target audience.
Do some market research. No matter what your business model is, it is always wise to have (and show) a good understanding of your market. This includes things like the size of the market segment, the demand for the product or service, consumer behavior, age and income of your target audience etc.
Write a competitive assessment. This basically entails looking for other businesses providing similar products and services domestically or internationally. And what makes you different / better than your competitors.
10. Get professional help
Sure, opening a sole proprietorship business is the simplest way to set up a business. But don't get hung up on the "sole" part. You will need professional help and advice in some areas so don't be shy to seek help. There are so many things that you may overlook, neglect or not even know about.
That is why it's important to consult with different types of experts such as a business lawyer, an accountant and a bookkeeper. Whether it's helping you record day-to-day business transactions, answering legal question or consulting on how to hire new employees, sometimes a bit of expert help is all you need to propel your business forward.
Starting a business is hard work. You put your heart and soul into building something so you owe it to yourself to do it right. As excited as you may be about setting up your business, take some time to figure out the best way forward. If creating a sole proprietorship is the most suitable form of business, by all means go for it. A profitable, well-managed business can give you the financial and non-financial freedom you dream of. Just make sure you're doing everything correctly from day one.