Contents
What’s it: A sole proprietorship is a business organization at its simplest. One person runs, is responsible for, and has complete control over the operations and profits of the business. It has no formal legal entity. Also known as a sole trader.
The various home businesses in your area are probably good examples of sole proprietorships. They include:
- Hairdresser
- Barber
- Local grocery store
- Freelance writer
- Freelance graphic designer
The owner may run a part-time or seasonal business. They usually rely on their own savings to run and grow their business. Other sources usually come from family or friends. Some may also access loans from banks.
Sole proprietorship characteristics
A sole proprietorship is the simplest business structure, with a single individual acting as the owner, operator, and decision-maker. Here’s a closer look at the defining characteristics of this business type:
- Single ownership: A sole proprietorship is owned and managed by one person. This individual is responsible for all aspects of the business, from daily operations to strategic planning.
- Unlimited liability: A critical feature of sole proprietorships is the concept of unlimited liability. This means that the owner’s personal assets (home, car, savings) are not legally separate from the business’s assets. If the business encounters financial difficulties, such as lawsuits or debts, the owner’s personal wealth can be used to satisfy those obligations.
- Full Control and decision-making: The owner of a sole proprietorship enjoys complete control over all business decisions. This includes aspects like marketing strategies, financial management, and product development. This level of autonomy allows for quick decision-making and flexibility in adapting to changing market conditions.
- Limited resources and size: Sole proprietorships are typically smaller businesses with limited financial resources. This can be a result of relying on personal savings or limited access to external funding. The smaller size often translates to a more localized customer base and a simpler organizational structure.
- Pass-through taxation: Sole proprietorships do not pay separate corporate income tax. Instead, the business’s profits “pass-through” to the owner’s personal income tax return. The owner then pays taxes on those profits at their individual tax rate.
- Limited continuity: The lifespan of a sole proprietorship is often tied to the owner’s involvement. If the owner dies, becomes disabled, or decides to close the business, the sole proprietorship typically ceases to exist. Developing a succession plan can help mitigate this risk.
Advantages of sole proprietorship
Suppose you run this business. Sole proprietorships offer several advantages, including:
Simple and cheap. A sole proprietorship requires little capital and does not require a formal legal entity. Thus, it is easy and inexpensive to set up. It also doesn’t require standard financial documents and reports, but it depends on how you manage them.
Full and direct control. You have full control over the operations and various business functions such as marketing, production, and finance. You make all the strategic decisions yourself and run the business the way you want.
Quick decision. Sole proprietorships do not have a standard organizational structure. Therefore, you are fully responsible for every decision. This allows you to make important decisions quickly, such as changing your target market or business model.
Flexible. As the owner, you decide how you organize and divide the work within the business. This business structure allows you to choose your time and work pattern. You can also choose what business you are in, maybe related to your skills or hobbies.
Full profit. All business profits are yours as the owner. You do not need to distribute dividends as in a limited company. In other words, you don’t have to share with others to enjoy the business profit.
Unregulated. Businesses have fewer rules and policies than other formal business organizations, such as private limited companies. You also do not have to register your company with the authorities because your business does not have a formal legal entity.
Single tax. Your business does not pay corporate profits tax; you only pay income tax.
Intimacy with stakeholders. You have direct personal contact with customers, suppliers, and employees. Business success depends on your interpersonal skills, such as negotiation skills. If you are successful, you can forge close personal relationships with these stakeholders.
Easy to end. Whether you want to stop or continue, all decisions are yours. If the business seems unprofitable, you can quit right away. On the other hand, you can close it and pursue another business that you find more promising.
Disadvantages of sole proprietorship
However, some disadvantages of sole proprietorships you should consider before choosing this business structure.
Unlimited liability. A sole proprietorship does not distinguish a business as a separate entity from the owner. Business’ assets and liabilities are not separate from personal assets and liabilities. So, you may have to sell personal assets such as a house or car to cover losses and pay off all liabilities, including bank loans.
Limited capital. The initial capital may come from your pocket or contributions from your friends or relatives. Access to external funding is more difficult because the business does not have a formal legal entity and is perceived as risky. For example, you may face difficulty borrowing funds from a bank—unless you already have a close relationship with the bank and trust it—and cannot issue shares on the Stock Exchange like a private limited company.
Limited business size. Sole proprietorships find it difficult to grow their business and expand due to limited capital. Thus, it is difficult for them to achieve higher economies of scale and lower costs due to the low production scale. In specific cases, owners may wish to remain in control of their own business and keep the size of the business small.
Low competitiveness. Due to its limited size and resources, your business often faces stiff competition from more established companies. As a result, it is difficult to beat the competition and survive in the market.
Relying heavily on the owner. Your business success highly depends on your qualities and skills as an owner. In addition to business management skills, you also need interpersonal skills to build good relationships with stakeholders and make your business a success. Suppose you pass the business on to your relatives, for example, your children. In that case, the business may not achieve the same success. Or, conversely, businesses are more successful than when you manage them because they are more proficient.
Low continuity. Since it has no separate legal status, the sustainability of the business depends on the owner. The business can end if the owner dies unless passed on to the next generation.
Recruitment can be difficult. You may have difficulty recruiting talent and professionals. They usually prefer more established companies that offer more job security and income.
Stress. Sole proprietorships usually do not have a clear and formal division of labor. As a business owner, you must make decisions, manage day-to-day operations, and develop competitive strategies. In other words, you have to perform many different roles in the business. It can involve long and tiring work hours, leading to stress.
