What is Sole Proprietorship?
Sole proprietorship is the most basic business form where an individual owns and runs a business and can also be referred to as individual entrepreneurship, sole trader, or proprietor. The business owner operates his business under a fictitious name.
A sole proprietorship is a popular and probably oldest business form in many countries because it is simple and easy to set up and operate.
This business form is usually preferred by local traders as it requires minimal cost to set up and run the business and other than that it requires a few formalities to be fulfilled to set up the business such as a business owner is only required to register his business and acquire all the local licenses to operate the business.
In a sole proprietorship, the trader is solely responsible for the debts of the business, but that does not mean that he can’t see employee people to help him to operate his business.
He can employ as many as people he requires to operate his business. Like all other business forms, sole proprietorship has both advantages and disadvantages associated with it.
In this article ahead, you will learn about the advantages and disadvantages of sole proprietorship business along with its features.
Example of Sole Proprietorship
The best example of sole proprietorship shops are individual owners of small businesses. For example, John’s spare Garage or Liz’s cake shop or Tony’s Pizza. All these businesses are run by the owner. The profits and losses belong to the owner and legally the owner is the business. If Tony’s pizza makes a huge profit, Tony alone earns the money. And Tony alone pays the taxes.
On the other hand, if Liz’s Cakeshop makes losses or has liabilities. then the liabilities belong to Liz herself. If you compare that to a corporation, then if a corporation has profits, the profits belong to the company. Not to the CEO or managing director. Similarly, if the company has losses or bad debts, they are of the company and not of the CEO or managing director.
A sole proprietor is a legal entity, but it is merely used as a trading name and is not a legal entity like a company or enterprise. In a sole proprietorship, there is no difference between the owner of the business and business entity.
Characteristics of Sole Proprietorships
1. Easy to form
One of the most important features of a sole proprietorships is that it is the easiest form of business to set up. The business owner is required to register the business under his name and get all the required local licenses to run the business.
Sole proprietorship business form is preferred by many small business owners because of its easiness to set up the business.
2. Individual Ownership
Another important feature of a sole proprietor business is that it is owned by a single owner. The owner of the business can start his business on his name.
Hence, there is no difference between the owner of the business and business entity, and the owner of the business is solely responsible for all the debts of the business.
3. Profit and losses are borne by business owner only
As business owner runs the sole proprietor business alone. Therefore, he is not liable to share the profits made by the business with anyone else, and he is only responsible for paying off the debts from his personal savings in case of losses incurred by the business.
4. Individual Liabilities in Sole Proprietorship
The liability in this is completely on the business owner. If the business is unable to pay off the liabilities of the business, then the business owner is responsible for paying them off using his personal properties like his savings, house, car, etc.
5. Individual Managerial Control
The managerial control of the business is in the hands of the business owner. Unlike enterprises, where owner and management are two separate entities. The owner of the business both runs and manages his business individually.
6. No difference between owner and business entity
Unlike a company, sole proprietorships are not an individual business entity. Legally, we can say that the owner of the business and the business have one identity. The responsibility of all business activities and transactions taking place in the business falls on the owner of the business.
7. Taxes in Sole Proprietorship
Filing tax of a sole proprietorship business is an easy task. The owner of the sole proprietorship is required to fill one or two pages tax form with internal revenue service along with his income tax return. In this form, the owner is required to mention all the revenues and expenses of the business.
8. Capital Investment
The investment of capital in a sole proprietorship business can be the owner’s savings or money borrowed from his friends or family or money borrowed from a bank in the form of a loan.
Unlike enterprises and companies, a business owner can’t obtain investment for the business by selling the shares of the business.
9. Dissolution of the business
A sole proprietorship business can be dissolved any time as per the will of the business owner if the business is not making profits or by court order if the business is involved in any type of illegal activities.
10. Sole power to make decisions
As an individual owns his business as a proprietor, he has the sole right to take all small and important decision about his business and is not required to consult others as others do not have any involvement in the business (like shareholders and board of directors have in enterprises).
11. The limited life of the business in Sole Proprietorship
The life of sole proprietorships is limited as it is dependent on the life and health of the business owner as the whole responsibility of running the business is only on the owner of the business.
Therefore, a business can’t carry on in case of the death or poor health of the owner or the owner can shut down the business at any time if he is incurring losses in the business.
12. The flexibility of running the business
The owner of the business has the freedom to run the business as per his own will. He can expand or shrink his business according to the performance of the business and can decide the working hours of his business.
13. Provide employment opportunities
In a sole proprietorship, a business owner can hire as many employees as he wants. Therefore, a sole proprietorship business also plays an important role in employing the society. However, the terms and conditions of employment remain the same as other businesses.
14. Freedom to choose and change business
Another feature of a sole proprietorship is the freedom to choose the type of business and the freedom to change the business at any time without taking the permission of others.
15. Small work area
As sole proprietorship business is owned and managed by the individual owner and the size of the business also depends on the resources of the owner. Therefore, the work area of the business is usually small and provides services in the local vicinity.
- The most important advantage of sole proprietorship business is that it is easy to set up as there are very few legal formalities such as registering the business on the name of the owner and getting local licenses to run the business.
- The owner of the business has complete control over the business, which gives him the freedom to run the business on his terms and take quick decisions for the business.
- The sole proprietor gets a great deal of confidentiality as he is not liable to make his accounts public (like the owner of a company is required to make his financial reports public for the shareholders and investors of the company).
- The profits earned from sole proprietorships belongs entirely to the owner of the business. He is not liable to share the profits made by his business with others.
- A business owner can increase and decrease the scale of the business as per his limits.
- This type of business provides you the satisfaction of being the boss of your own business. You are not liable to answer to anyone for the decisions that you take, and you can also employ people.
- The owner of the sole proprietorship business enjoys the tax relaxations as tax applied on sole proprietorship business is quite low as compared to other business types.
- It is easy to dissolute.
- It is easy to keep the records as sole proprietorship businesses are usually of small scale.
- The main disadvantage is the unlimited liability of the business owner. If a business incurs losses, then only the owner of the business is responsible for paying off the debts from his private property.
- There is a limited capital investment in the sole proprietorship business. The business owner either can invest from his savings or can take a loan from the bank.
- Sole proprietorship businesses have a limited life span and are dependent on the life of the owner of the business. Such business can’t carry on without the proprietor.
- The burden on the owner, as all the work responsibilities such as operating business, hiring employees, and managing the business lies on the shoulders of the business owner.
- Sometimes business owner might end up taking quick and poor decisions due to the lack of expertise in the area or lack of experts’ opinion, which can result in financial losses.
How to Start a Sole Proprietorship?
The following should be put into consideration when starting a sole proprietorship;
- Understanding the business: The business owner must understand that a sole Proprietorship has no partners and is owned by one person who has absolute say in all business operations.
- Choice of name: Any name may be chosen so long as it not undesirable, vulgar, offensive, restricted for registration, reserved under the business Names registration act and identical to one already registered.
- Place or address of business: The owner of the business notifies the registrar of the principal place of business and any other place the business may be carried out. It is important to note that the postal P.O box address may not be considered as the business address. Again, homeowners can be allowed to conduct the business from the residential premises however an application for this has to be submitted
- Authorized business representatives: Any person can be appointed as a sole trade representative if he is over 18 years old, has a sound mind and is a local resident.
- Foreigners: Any foreigner who wishes to start this form of business must appoint a local resident who will be representative of the business. If the foreigner needs to register the said business and is not residing in the country of business, he has to seek a local resident partner
- Registration: When doing registration, the business name, the business address, the name and address of the authorized owner will be required.
- Renewing: In most places, registration of sole proprietorship is usually valid for a year after which it is renewed. It is an offense to conduct business activities before renewal of license as this might attract a fine which is a liability to the business
A sole proprietorships are a good starting point for doing business.
With time, since it is easy to manage, returns can be plowed back thereby growing into a small Corporation and later a Limited Liability Company (LLC)