Setting Up a Company vs. Being a Sole Proprietor

Entrepreneurs often ask the question, “do I have to set up a company to start providing my product or service?”. The answer is technically “no”, but while there are some cost savings associated with remaining as a sole proprietor (i.e., not setting up a company), there are also significant risks especially if your business has any expectation of growth or sophistication.

“While there are some cost savings associated with remaining as a sole proprietor (i.e., not setting up a company), there are also significant risks especially if your business has any expectation of growth or sophistication.” 

Do I need to set up a company?

Over 70 percent of U.S. businesses are owned and operated by sole proprietors or sole traders. But what does being a sole proprietor involve and is it the right structure for your small business? Here’s what you need to know about the advantages and disadvantages of being a sole proprietor.

What is a sole proprietor?

A sole proprietorship is basically an unincorporated business owned and run by one individual (no partners are involved), with no distinction between the business and its owner. As a sole proprietor, you are entitled to all profits and are responsible for all your business’s debts, losses and liabilities.

A sole proprietorship is the easiest business structure to form (you only need to get a license or permit and register your business with your local government) (hence its popularity). It is also a simple structure to maintain with few forms and little business administration needed. Many freelancers, consultants and independent contractors operate as sole proprietors for ease and convenience. SBA’s Sole Proprietor Guide offers more details about the process of starting a business as a sole proprietor and the steps you’ll need to follow.

What are the advantages of being a sole proprietor?

• Ease. As mentioned above, the ease of starting and operating a sole proprietorship is one of the reasons this business structure is hugely popular.
• Low Regulation. Also, sole proprietors are relatively unencumbered by government regulations and can run their business autonomously without the need to report to partners, shareholders and board members. You control all your own decisions and the money you make.
• No Need for a Company Tax Return. Sole proprietors have the benefit of reporting tax on any income earned through their own personal tax return, rather than filing separately as a business – which can save time and hassle. You also won’t need to prepare a balance sheet for your company.
• Flexibility. Sole proprietors also have a lot of flexibility when it comes to their careers. You can easily close your business without too much bureaucracy, or work on a full or part-time basis for another employer without worrying about answering to anyone about your own business affairs (aside from your clients, of course) – another reason this is a popular option for freelancers, many of whom hold down two jobs!

What are the disadvantages of being a sole proprietor?

• Liability. If you are a sole proprietor, you can be sued personally for acts that occur related to the business. This means someone could go after your personal assets (e.g., car, house, personal bank accounts). You may not think now that you need protection against liability, but what if a client holds you in breach of contract or threatens to sue you? Can you afford to put your personal assets at risk to satisfy any claims against your business? As a sole proprietor, there is no legal distinction between the owner and the business. This means that you are personally liable for all business losses and debts. Business incorporation can limit your liability as a business owner, essentially putting your personal assets off limits if anyone brings a judgment against you.
• Difficulty Obtaining Financing. Other disadvantages can potentially impact your bottom line and growth plans. For example, banks typically require that businesses incorporate before they’ll lend them money, leaving you to rely on savings, credit cards and other sources of capital. Then there’s the perception issue – being an incorporated business can give you a more professional appearance to potential clients.
• Lack of Financial Controls. Finally, because you aren’t required to produce financial statements or a balance sheet, your financial controls might not be as sharp as the need to be and this could be detrimental in the long term.
• Lack of Professionalism. Many perceive the lack of a company a a sign of a less professional business.

While there are some benefits, we recommend setting up a company for anyone who is serious about spending real money and making a real commitment to an entrepreneurial venture.