A sole proprietorship is the simplest entity type for new businesses, and it’s also quite a popular option for entrepreneurs in a number of different industries.
Despite that popularity, though, the sole proprietorship is often misunderstood as a business structure.
The sole proprietorship is an informal business type that does not require any sort of registration with your state government ― all you need to do to form one is to start working. That said, while this business structure lacks official rules and regulations, there are still some general guidelines that you should adhere to when operating a sole proprietorship.
That’s why we’ve compiled a quick list of six of the most common sole proprietor myths, and the truths behind them. If you have questions about what it’s really like to operate as a sole proprietor, read on to get all the information you need about this simple and informal business structure.
Formation paperwork actually doesn’t exist for a sole proprietor. Technically, a sole proprietorship forms automatically whenever the owner first starts conducting business. In this way, the sole proprietorship is essentially a one-person version of a general partnership.
This differs significantly from more formal entity types, such as corporations and limited liability companies (LLC), because these business types have to file formation documents with the Secretary of State.
But if you go looking for sole proprietorship documents on your state’s Secretary of State website, you won’t find any. Because a sole proprietorship is an unincorporated entity, there is minimal state and federal oversight regarding how they should be formed and maintained.
If you’re looking for the absolute easiest way to start a business by yourself, the sole proprietorship is definitely it.
Starting off as a sole proprietor is as easy as business ownership gets, but some entrepreneurs find that they outgrow this business structure. While you might think that once you start a sole proprietorship, you’re stuck with this business type, that’s not actually true.
Even if you operate your business for years as a sole proprietorship, there’s nothing stopping you from forming a formal business entity (like an LLC or corporation) down the line. Many successful companies started off as sole proprietorships before growing into major corporations years later.
If you find that you need personal asset protection, or if you want a unique business name reservation that can’t be used by any other companies, you can always convert your sole proprietorship into a corporation or LLC later.
This myth is completely false. While many sole proprietorships are one-person operations, they don’t have to be. As long as a sole proprietorship obtains a federal tax ID number (also commonly known as an EIN), the business can have employees.
The only caveat is that those employees cannot also be owners of the business ― if you want your employees to also co-own the business with you, you’ll have to form a different business entity. Thankfully, as we just discussed, you can do that at any time!
A sole proprietorship does not have personal asset protection. That protection is only possible for businesses with a corporate veil, like an LLC. This veil separates the assets of the business from the personal assets of the owners, and to maintain that separation, businesses have to keep all finances separate.
If they don’t, they lose the protection provided by their veil.
In contrast, a sole proprietorship is indistinguishable from the person who owns it. This means that, in the eyes of the law, there is no difference between the owner’s assets and those of the business, so for sole proprietors, there is no asset protection of any kind.
If a corporation or LLC fails to separate its personal finances from its business finances, there are legal repercussions, but a sole proprietorship does not have that risk.
Bookkeeping is not an exciting part of running a business, so because they’re not legally required to keep their assets separated, some sole proprietors might be tempted to skimp on accounting practices. However, sole proprietors should still keep their business and personal finances as separate as possible.
For one thing, completely separate accounts gives you practical knowledge, as it helps you keep track of your bottom line for each year, and there are also your taxes to consider. If you have a clear separation between your accounts, then it’s easier to prove any deductions you make for your business. Audits are far simpler when your accounts are clearly defined.
“Unincorporated” does not mean a business is illegitimate — far from it, in fact. A sole proprietorship is an entirely legitimate business structure, and it can be quite successful as well.
Some of today’s top-tier businesses actually started out as sole proprietorships. Take Ebay, for example. Ebay is now famous for its online auctions and bargains on used and collectible goods, but at first, it was a sole proprietorship.
A sole proprietorship is less formal than an LLC or a corporation, but that doesn’t mean it can’t be successful. It serves as a helpful starting point for many big companies, and some prosperous companies remain sole proprietorships well into their business life cycles.
It is true that the sole proprietorship operates without some of the important benefits that more formal business structures enjoy, such as personal asset protection.
However, just because the sole proprietorship is a simple, informal business type doesn’t mean that it isn’t a legitimate structure with some advantages of its own.
Whether you decide to form a sole proprietorship or a formal business structure like an LLC, we hope this article helped you figure out the truth behind these common sole proprietor myths. If you do decide to form an LLC, popular LLC services like Incfile or ZenBusiness can take care of the paperwork for you.
Disclaimer: The content on this page is for informational purposes only, and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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