Sole proprietorship

A business organization that is unincorporated and has only one owner.

Investopedia Says:
The other two types of organizational structures are partnerships and incorporated companies (corporations).

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Business or financial venture that is carried on by a single person and is not a Trust or Corporation. A sole proprietor (sole owner) has unlimited liability. Schedule C of Form 1040 is used to report income and expenses of a sole proprietorship.

Ownership of a business, with no formal entity as a vehicle or structure. Contrast with Corporation, Limited Partnership, Partnership.
Example: Jessica goes into the real estate appraising business with all business activities in her own name and no partners. She is a sole proprietor.

A sole proprietorship is the simplest form of business ownership. Not surprisingly, the vast majority of small businesses begin their existence as sole proprietorships. A sole proprietorship has but one owner. That sole owner may engage in any form of legal business activity any time and anywhere. Other than the various local and state business licenses that every business must purchase regardless of type of ownership, no legal formalities are required to start or operate the business. The owner is responsible for securing and investing the funds for the business. These funds may come from the owner's existing or borrowed financial resources.

The Internal Revenue Service (IRS) permits one exception to the "one sole owner" rule. If the spouse of a married sole proprietor works for the firm but is not classified as either a partner or an independent contractor, the business may still considered to be a sole proprietorship and forgo having to submit a partnership income tax return. Also, the sole proprietorship can avoid self-employment taxes.

If the owner's true name is used, such as "John Smith Auto Repair," there is ordinarily no problem in selecting a name for the sole proprietorship. But care must be taken if a fictitious name is contemplated. The owner must register the name with the county to see whether the name duplicates that of another business. Even if it does not, the owner must submit a "doing business as (dba)" form to the county, or, in a few states, to the secretary of state.

Advantages

An owner of a sole proprietorship gets to keep all profits derived from the operation but must also bear all losses. The owner may even share any portion of the profits and losses with another person or persons.

The owner has the authority to make all the decisions relating to the business. Since there are no co-owners, there is no need to hold policy-meeting sessions or form any group similar to a board of directors. The owner, of course, must bear the responsibilities that accrue from the decisions made.

The owner may hire employees or work with independent consultants and still retain the sole proprietorship form of ownership. Even if these employees or independent consultants are requested to offer their opinions relating to the firm's business decisions, the opinions are considered to be only recommendations. The owner cannot abdicate any responsibility for the outcomes fostered by these recommendations.

Disadvantages

Unlimited liability is the major disadvantage borne by the sole proprietorship. The owner is financially responsible for satisfying all business debts and/or losses suffered by the firm, even to the point of sacrificing his or her personal or other business interests to pay off any liabilities. For example, assume a lawsuit inflicts a debt of $190,000 on a sole proprietorship that is able to contribute only $85,000 toward settlement of the liability. Further assume that the proprietor owns a home, equipment, and other business investments totaling $365,000.

The following shows the picture of the owner's liability:

Total liability of the proprietorship $190,000

Capability of the proprietorship in settling the liability $85,000

Extent to which the owner's personal assets (totaling $365,000) must be used to settle the debt $105,000

Owners of sole proprietorships have severe potential liabilities from customers, competitors, lenders, employees, and even government. The cost of liability insurance or of defending against a lawsuit is beyond the financial capability of many business firms. For this reason, most individuals holding somewhat extensive personal assets do not ordinarily use the sole proprietorship form of ownership. Instead, an alternative form of ownership is often used, such as corporation or special forms of partnership, that eliminates the unlimited liability.

Termination of the Business

A sole proprietorship legally terminates immediately upon the death of the owner. Even if a spouse, relative, or friend of the deceased owner assumes ownership and keeps the business operating under the same name, legally a new business enterprise has been formed. It is recommended that owners at least make a will, and preferably a revocable trust, to name the beneficiary of the owner's interest in the business.

A sole proprietorship also terminates if the ownership interest is sold to another person or group of persons, if the business is abandoned by the owner, or if the owner becomes personally bankrupt.

These potential risks of sudden termination place sole proprietorships at a serious disadvantage in attracting top-flight employees who may not to wish to tie their future to a business that may suddenly become inoperative.

Income Taxes

When filing an income tax return, no legal distinction exists between a person as a sole proprietor and an individual person. The sole proprietor's personal income tax return (Form 1040) must include calculation of the proprietorship's income tax as well as any income or loss that the owner incurs from any additional entity, such as an employee, investor, or the like.

If, for example, a taxpayer realizes net earnings of $65,000 from a sole proprietorship and $28,000 from investments, the IRS considers the total net income to be $93,000. But, on the other hand, if a sole proprietor suffers a net loss of $42,000 from the business and a $71,000 net income from investments, the IRS would consider the total income to be $29,000.

Sole proprietors use Schedule C of IRS Form 1040 to file their income tax return for the proprietorship section of their income. The details of Schedule C can get very involved; many sole proprietors require professional advice for this phase of their income tax report.

Where applicable, sole proprietors file Form 4562 to report depreciation and amortization, and Form 8829 to report business use of the owner's residence.

Types of Business

Proprietorships engage in a wide variety of businesses. Using the major categories of the new North American Industry Classification System (NAICS), the types of business activity that small businesses (including sole proprietorships) are likely to be involved an as follows:

Accommodation, food services, and drinking places

Administrative and support and waste management remediation services

Agriculture, forestry, hunting, and fishing

Arts, entertainment, and recreation

Construction

Educational services

Health care and social assistance

Information

Manufacturing

Mining

Professional, scientific, and technical services

Real estate and rental and leasing

Religious, grant making, civic, professional, and similar organizations

Retail trade

Transportation and warehousing

Utilities

Wholesale trade

Requisites for Success

Success does not come easily for small business enterprises. To achieve success, authorities have recommended a number of characteristics and activities.

Successful sole proprietors should be strong physically and emotionally. It is very important that they be in good health. Attitudes of business owners are critical; they should possess a positive outlook and enthusiasm. They should be receptive to advice. They need to work very hard, particularly during the first several years.

Sole proprietors should possess considerable business experience, especially in the product or service lines offered by their business. Having an appropriate and sufficient education is very valuable. Other capabilities could be added, such as getting along with different kinds of people, having the ability to plan and organize, knowing how to arrive at and carry out decisions, and being a self-starter.

It is often recommended that sole proprietors select a type of business in which they have both skills and interest. The geographic location should be investigated thoroughly regarding its growth potential. And it may be important for a sole proprietor to consider having a partner.

In setting up a business, a new sole proprietor should do the following:

• Learn as much as possible about the product or service being offered for sale
• Make sure there is enough capital available to meet necessary equipment and building needs as well as to pay for the first year's operating expenses
• Determine the amount to be invested and find the sources of any necessary loans
• Secure the assistance of an accountant, attorney, insurance agent, and banker
• Become familiar with licenses required, zoning laws, and other regulations
• Determine the most desirable types of employees; take steps to locate them and interest them in applying; and learn how to handle all withholdings
• Learn the fundamentals of advertising and, if appropriate, store layout
• Make sure that the appropriate forms of accounting and record keeping are established, and see that balance sheets and income statements are prepared
• Learn all aspects of marketing, including the principles of determining market share

In addition, the new sole proprietor should write a thorough business plan. The Small Business Administration provides the following outline for the elements of a business plan:

• I. Cover sheet
• II. Statement of purpose
• III. Table of contents
• A. The Business
• 1. Description of business
• 2. Marketing
• 3. Competition
• 4. Operating procedures
• 5. Personnel
• 6. Business insurance
• 7. Financial data
• B. Financial data
• 1. Loan applications
• 2. Capital equipment and supply list
• 3. Balance sheet
• 4. Break-even analysis
• 5. Pro-forma income projections (profit and loss statements)
• Three-year summary
• Detail by month, first year
• Detail by quarters, second and third years
• Assumptions upon which projections were based
• 6. Pro-forma cash flow
• C. Supporting documents
• Tax returns of principals for last three years
• Personal financial statement
• Copy of franchise contract and all supporting documents if appropriate
• D. Copy of proposed lease or purchase agreement for building space
• Copy of licenses and other legal documents
• Copy of resumes of all principals
• Copies of letters of intent from suppliers, and so forth

Seeking Advice

Sole proprietors find it very helpful to consult with other sole proprietors who successfully operate a business. Many also seek the advice of the Small Business Administration (SBA), an independent government agency.

Organized by Congress in 1953, the SBA now has offices in nearly every major city in the United States. Its toll-free telephone number is 1-800-8-ASK-SBA. Among many other services, SBA sponsors the Service Corps of Retired Executives (SCORE), Business Information Centers (BICS), and Small Business Development Centers (SBDC).

Bibliography

Bustner, Irving. (1993). Start and Run Your Own Profitable Service Business. Englewood Cliffs, NJ: Prentice-Hall.

Davidson, Robert L., III. (1991). The Small Business Partnership Kit. New York: Wiley.

Diamond, Michael, and Williams, Julie. (1996). How to Incorporate, A Handbook for Entrepreneurs and Professionals, 3d ed. New York: Wiley.

The Small Business Administration. www.sbaonline.sba.gov.

[Article by: G. W. MAXWELL]

A form of business in which one person owns all the assets of the business, in contrast to a partnership or a corporation.

A person who does business for himself is engaged in the operation of a sole proprietorship. Anyone who does business without formally creating a business organization is a sole proprietor. Many small businesses operate as sole proprietorships. Professionals, consultants, and other service businesses that require minimum amounts of capital often operate this way.

A sole proprietorship is not a separate legal entity, like a partnership or a corporation. No legal formalities are necessary to create a sole proprietorship, other than appropriate licensing to conduct business and registration of a business name if it differs from that of the sole proprietor. Because a sole proprietorship is not a separate legal entity, it is not itself a taxable entity. The sole proprietor must report income and expenses from the business on Schedule C of her or his personal federal income tax return.

A major concern for persons organizing a business enterprise is limiting the extent to which their personal assets, unrelated to the business itself, are subject to claims of business creditors. A sole proprietorship gives the least protection because the personal liability of the sole proprietor is generally unlimited. Both the business assets and the personal assets of the sole proprietor are subject to claims of the sole proprietorship's creditors. In addition, existing liabilities of the sole proprietor will not be extinguished upon the dissolution or sale of the sole proprietorship.

Unlike the managers of a corporation or a partnership, a sole proprietor has total flexibility in managing and controlling the business. The organizational expenses and level of formality in a sole proprietorship are minimal as compared with those of other business organizations. However, because a sole proprietorship is not a separate legal entity, it terminates when the sole proprietor becomes disabled, retires, or dies. As a result, a sole proprietorship lacks business continuity and does not have a perpetual existence as does a corporation.

For working capital, a sole proprietorship is generally limited to the individual funds of the sole proprietor, along with any loans from outsiders willing to provide extra capital. During her lifetime, a sole proprietor can sell or give away any asset because the business is not legally separate from the sole proprietor. At the death of the sole proprietor, the business is usually dissolved. The proprietor's estate, however, can sell the assets or continue the business.

See: S Corporation.

Companies law

Company · Business Sole proprietorship Partnership (General · Limited · LLP) Corporation Cooperative

United States

S corporation · C corporation LLC · LLLP · Series LLC Delaware corporation Nevada corporation Massachusetts business trust

UK / Ireland / Commonwealth

Limited company (by shares · by guarantee Public · Proprietary) Community interest company

European Union / EEA

SE · SCE · SPE · EEIG

Elsewhere

AB · AG · ANS · A/S · AS · GmbH K.K. · N.V. · OY · S.A. · more

Doctrines

Corporate governance Limited liability · Ultra vires Business judgment rule Internal affairs doctrine De facto corporation and corporation by estoppel Piercing the corporate veil Rochdale Principles

Related areas

Contract · Civil procedure

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This article needs additional citations for verification. Please help improve this article by adding reliable references. Unsourced material may be challenged and removed. (May 2009)

A sole proprietorship also known as a sole trader, or simply proprietorship is a type of business entity which is owned and run by one individual and where there is no legal distinction between the owner and the business. All profits and all losses accrue to the owner (subject to taxation). All assets of the business are owned by the proprietor and all debts of the business are his debts and he must pay them from his personal resources. This means that the owner has unlimited liabilty. It is a "sole" proprietorship in the sense that the owner has no partners (partnership).

A sole proprietor may do business with a trade name other than his or her legal name. This also allows the proprietor to open a business account with banking institutions.

Advantages

The main advantages of sole proprietorship are ease to start up, relatively fewer regulation, full control over the business, easy to discontinue. Another advantage is that one takes all the profits of the business. This is the main reason that most businesses are of this type. A sole proprietorship is not a corporation; it does not pay corporate taxes, but rather the person who organized the business pays self employment taxes on the profits made, making accounting much simpler. A sole proprietorship also does not have to be concerned with double taxation, as a corporate entity would. A sole trader doesn't have any opposition when taking a decision as he has total control

Disadvantages

A business organized as a sole trader will likely have a hard time raising capital since he has to make up for all the business's funds. The owner of the business has unlimited liabilty as he is responsible for the business's debts because he has control over the business.

In countries without universal health care, such as the United States, a sole proprietor is also responsible for his or her own health insurance, and may find difficulty finding any if one of the family members to be covered has a previous health issue.

Another disadvantage of a sole proprietorship is that as a business becomes successful, the risks accompanying the business tend to grow. To minimize those risks, a sole proprietor has the option of forming a corporation, or, more recently, a Limited Liability Company.

References

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