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:
- 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 to banks.
Sole proprietorship characteristics
One person as a business owner. However, the owner may also hire some employees. Other characteristics of sole proprietorships are:
- Business does not have a formal legal entity.
- The owner is responsible for and has full control over the business’s finances, profits, and operations.
- The owner’s liability is unlimited.
- Owners may lose the personal property if the business fails to meet obligations.
- The business can end when the owner dies.
- Businesses do not cover corporate taxes.
- The owner only bears personal income tax.
- The business is small in size and has limited resources.
- Businesses are considered risky and vulnerable to competition due to low competitiveness.
- The scale of operation is limited due to limited capital and target market.
- Businesses usually only cater to local requests – however, some may rely on internet channels to extend their reach.
Sole proprietorship advantages
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 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. As a result, it allows you to quickly make important decisions, such as changing your target market or business model.
Flexible. How you organize and divide the work within the business is up to you as the owner. So, this business structure allows you to choose the time and work pattern according to your wishes. 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. So, you only pay your 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.
Sole proprietorship disadvantages
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. I mean, business assets and liabilities are not separate from your 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 you – 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.
The difficulty for recruitment. You may have difficulty recruiting talent and professionals. They usually prefer more established companies which 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.