How to start a sole proprietorship
Anyone looking to take the leap and become self-employed can start a sole proprietorship in the US. You don’t need a massive budget nor any potential business partners to get going. Whether you’re in the business of selling or providing a service – once you know what you want to do, it’s easy to become a sole proprietor. An estimated 23 million businesses in the US are sole proprietorships. But it’s important to understand the requirements, taxation rules and liabilities of a sole proprietorship.
What’s a sole proprietorship and who can start one?
A sole proprietorship is a legal business form that is set up and maintained by a single person. But before you opt for a sole proprietorship, you should consider the alternatives such as a corporation or limited liability company (LLC), both of which can be run by a single person. The main difference between a sole proprietorship and the corporation and LLC are that the latter exist as separate legal entities from the owner. As a sole proprietor, you’re also fully liable for your business. Neither of the three options requires you to have any capital to launch with. However, although there are legal benefits to registering as a corporation or LLC, the process requires considerably more paperwork and time. Because of that, sole proprietorships are still the most common legal business structure in the US.
Advantages and disadvantages of a sole proprietorship
Although you can always revert to a different legal business structure later on, it’s worth having an overview of the advantages and disadvantages of a sole proprietorship. You may find that a corporation or LLC suits your business needs a little better.
| Advantages | Disadvantages |
|---|---|
| Easy to set up. A sole proprietorship requires no starting capital. Set-up costs are usually minimal depending on your business, but there are no registration fees. | Personal liability. As a sole proprietor, there is no separation between you and your business. That means you can be personally held accountable for any debt or employee issues. |
| Control. You are the sole owner of the business which means that you will have full control over any business decisions you make. | Decisions. Because you have sole control over the business, any decisions you make are your responsibility. That means you are fully responsible for the failures and successes of the business. |
| Simplified accounting. Tax returns by sole proprietors are a lot less complicated than for other business structures because you’re not taxed separately. Tax rates are also lower. | Limited investment opportunities. Sole proprietors have a much harder time raising funds because there’s a greater risk for shareholders and investors if the business is not profitable. |
How to start a sole proprietorship – step-by-step
There are many different types of industries in which you can become a sole proprietor. For example, you could start a catering business, run a tutoring service, offer your skills as an accountant or landscaper. You may even realize that you’re already running your current business as a sole proprietor. That’s because setting up a sole proprietorship is so easy to do in the US. If you’re planning to start a sole proprietorship, here’s what you need to do.
Step 1: Choose a name
Most sole proprietors operate their business under their own name. But it can be worth choosing a more dedicated name that accurately describes what services or products your company provides. A strong name is one that reflects your business purpose, is easy to remember and that is not registered already. Once you’ve made your choice, you can register a web domain under the name. Most businesses today have their own website and social media presences. If your business name is not your actual name, you should register it with your local authority as “doing business as”. You can also trademark a name if you feel strongly about it or your business idea.
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Step 2: Business bank account
Although it’s not technically necessary to have a separate business account, it could save you some hassle down the line. Keeping your business finances separate from your personal finances makes it easier to retain an overview of profits and losses. You can open a separate business account and get a dedicated business credit card, which you only use for your company expenses.
Step 3: Get a business license
For certain business types, you may need to register for an operational license or a permit to operate. For example, if your business is within construction, childcare or law, you must get an operational license. If you sell restricted items such as alcohol, firearms or tobacco products, you must also register for a federal license. In certain cases, where you’re using land to grow crops, you need a permit. The sale of food and health items also requires you to register for a permit.
Step 4: Accounting
In most cases, sole proprietors’ accounts are fairly simple. If, for example, you’re a graphic designer, you may only work with a few clients a year and write invoices to each at the end of each month or when a project is finished. It’s a good idea to keep a record of your invoices and any expenses (for example, new software or hardware you need to operate your business) using an Excel spreadsheet. If you write a lot of invoices, employ contractors or need more advanced accounting tools, you can try one of many useful accounting apps.
Step 5: Paying taxes
Just like any other business, sole proprietors must pay taxes. The difference between being employed and being self-employed is that you will be required to list your profits but also your losses when submitting the 1040 form to the Internal Revenue Service (IRS). You can deduct business expenses and will be taxed on your net income. It’s important that throughout the year you set aside enough money to pay your taxes. If your income from self-employment exceeds $400 a year, you will be required to pay taxes of 15.3% on the remaining net income. The tax is composed of social security and Medicare.
If your business has employees, you must also pay employment taxes on their income. These can be deducted as business expenses.
Risks involved when setting up a sole proprietorship
Although there are lots of benefits of being a sole trader, it is an unincorporated business entity and there are several risks involved. Firstly, sole proprietors are personally liable for any debts the business produces. They cannot file for bankruptcy and depending on the amount of debt owed, may have to sell personal assets to settle overdue payments. Where sole proprietors put everything on the line, they may end up losing everything in a worst-case scenario.
Because investments are harder to secure under a sole proprietorship, there’s a danger that you may lose your own money in the long run where a business idea doesn’t take off. Alternatively, you may not be able to sustain your business if you cannot secure funding.
You can also be held accountable for any injuries you may cause during business operations. It’s best to purchase liability insurance if your business involves physical activities that could potentially harm yourself or others.
Starting a business is risky, no matter which legal structure you choose. If you want to test the waters with an idea that doesn’t require too much cash investment, sole proprietorships offer a good structure. Nevertheless, you should create a realistic business plan that assesses any competitors as well as your potential customers. Having an in-depth understanding of your potential customers will make it easier to weigh the risks and determine how likely you are to succeed. Whether you ultimately do succeed depends on your goals, your efforts and of course the market.
Checklist for starting a sole proprietorship
The following steps are necessary to set up a sole proprietorship:
- Business idea and drafting a business plan
- Deciding on a name for your business
- Opening a business bank account
- Registering your trademark (where necessary)
- Where appropriate, registering/applying for permits and business licenses
- Keeping accounts (you can download an accounting app or software to help with invoicing)
- Pay taxes
Click here for important legal disclaimers.
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