As a new business owner, you have choices to make, including picking a legal structure for your enterprise. You can choose to run your business as a corporation or a limited liability company if you want to go through the trouble of setting up an independent business entity. In many cases, operating as a sole proprietorship provides enough structure for a successful business with fewer formalities.
Easy setup is one of the main characteristics of a sole proprietorship. Independent business entities, such as corporations and LLCs, must file business formation paperwork with a state agency before operating. Drafting the paperwork, filing it and receiving approval from the government can take weeks and cost hundreds of dollars. In most states, a business owner who operates as a sole proprietor can engage in business activity without filing any paperwork with the state, as long as he operates the business under his own legal name.
Another primary characteristic of a sole proprietorship is the unlimited personal responsibility of the owner. One of the caveats of not having to file business registration paperwork with most states is that the owner takes full responsibility for anything that happens regarding the business. If the business cannot pay its bills, for example, creditors can come after the personal assets of the owner, including the owner’s house and family bank accounts. Likewise, a court judgment entered against the business will show up on the owner’s credit report as a personal debt.
By legal definition, a sole proprietorship can have only one owner. This characteristic means that the buck starts and stops with the owner. The sole proprietor does not have to answer to a board of directors or a business partner. There is no need to draft bylaws or a partnership agreement to control operations and management. The proprietor can choose to run the business however she likes.
A sole proprietorship is distinct in the way the owner pays federal taxes on business income. Instead of filing a separate annual tax return to report business income and expenses, a sole proprietor reports these amounts on Schedule C of his personal income tax return. This tax reporting process is much easier than what is required of other types of entities, and it allows business income to be taxed at the owner’s individual tax rate.
Another primary characteristic of a sole proprietorship that is not always obvious to new business owners is the inability to raise money and resources for the business by selling equity. A sole proprietor cannot sell shares of stock or bring on partners in exchange for an investment in the business. If a sole proprietor wants to bring on equity investors, she must change the legal structure of the business.