- September 26, 2011
- Posted by: Orkun Ozkaymak, CPA, MBA
- Category: Business Formation
The sole proprietorship is the simplest business form under which one can operate a business. The sole proprietorship is not a legal entity. It simply refers to a natural person who owns the business and is personally responsible for its debts. A sole proprietorship can operate under the name of its owner or it can do business under a fictitious name, such as Nancy’s Nail Salon. The fictitious name is simply a trade name–it does not create a legal entity separate from the sole proprietor owner.
The sole proprietorship is a popular business form due to its simplicity, ease of setup, and nominal cost. A sole proprietor need only register his or her name and secure local licenses, and the sole proprietorship is ready for business. A distinct disadvantage, however, is that the owner of a sole proprietorship remains personally liable for all the business’s debts. So, if a sole proprietor business runs into financial trouble, creditors can bring lawsuits against the business owner. If such suits are successful, the owner will have to pay the business debts with his or her own money.
The owner of a sole proprietorship typically signs contracts in his or her own name, because the sole proprietorship has no separate identity under the law. The sole proprietor owner will typically have customers write checks in the owner’s name, even if the business uses a fictitious name. Sole proprietorships can bring lawsuits (and can be sued) using the name of the sole proprietor owner. Many businesses begin as sole proprietorships and graduate to more complex business forms as the business develops.
Advantages of the Sole Proprietorship
- Owners can establish a sole proprietorship instantly, easily, and inexpensively.
- Sole proprietorships carry little, if any, ongoing formalities.
- A sole proprietor need not pay unemployment tax on himself or herself (although he or she must pay unemployment tax on employees).
- Owners may freely mix business and personal assets.
Disadvantages of the Sole Proprietorship
- Owners are subject to unlimited personal liability for the debts, losses, and liabilities of the business.
- Owners cannot raise capital by selling an interest in the business.
- Sole proprietorships rarely survive the death or incapacity of their owners and so do not retain value.