The sole pro­pri­etor­ship: Every­thing a business founder should know

Many employees dream of becoming their own boss. What they might not realize is that it’s easy to get started. All you need is a promising business idea, good prepa­ra­tion, and con­fi­dence in your own abilities. You can become a sole trader without any large seed capital from in­flu­en­tial business partners. But what pre­req­ui­sites need to be met, what for­mal­i­ties must be observed, what is the business day like, and what risks should you be aware of in advance?

With a sole pro­pri­etor­ship, anyone who wants to become self-employed in the USA can easily set up their own business. As the name suggests, the pre­req­ui­site is that it is founded and managed by an in­di­vid­ual. However, you can hire as many employees as you like from the start, or with in­creas­ing business success.

The sole pro­pri­etor­ship is an in­de­pen­dent legal form, which stands on equal footing with cor­po­ra­tions that are also managed by a single person. However, to create a cor­po­ra­tion, the law often pre­scribes a minimum capital amount necessary. This isn't the case for sole pro­pri­etor­ships, making it much easier for young en­tre­pre­neurs to move into self-em­ploy­ment. This is one of the most important reasons why the sole pro­pri­etor­ship is the most widely used business structure in the USA.

For more in­for­ma­tion on setting up a sole pro­pri­etor­ship, for more in­for­ma­tion, see our guide on starting your business as a sole pro­pri­etor.

What dis­tin­guish­es the sole pro­pri­etor­ship from other business forms? It is on a level with cor­po­ra­tions and part­ner­ships, and, like these, is also bound by certain re­quire­ments - from rules on tax treatment to business reg­is­tra­tion. Once you un­der­stand the rights and oblig­a­tions of a sole pro­pri­etor, you can decide whether or not it is the right choice for your business idea. If you have any doubts, you should seek the help of pro­fes­sion­al con­sul­tants.

First things first, the company must be given a name. Small busi­ness­es and free­lancers often use their own names as their business names, attaching an addendum that clearly describes the industry or specific service provided. If you prefer to choose a different name other than your own, you will be required to register your company name with your local Secretary of State. If the name is already taken, you will have to select a different one. We recommend selecting an industry-typical name, which makes it obvious to potential customers and business partners what goods and services you’re offering.

The man­age­ment usually connotes the owner or founder of the company, but it is important to remember that the term “managing director” should not be used, since this is an official title in the hierarchy of a cor­po­ra­tion. This could result in an official warning. Referring to yourself as the “owner” means you are on the safe side.

The owner has the pos­si­bil­i­ty to transfer the conduct of business by com­mer­cial powers to another person, or to share man­age­ment re­spon­si­bil­i­ties. This makes sense if the company continues to grow and becomes difficult to manage by a single person.

There is no required start-up capital for setting up a sole pro­pri­etor­ship. However, it is not possible to start a business without some kind of financial reserve, because depending on the company, machines, tools or basic office equipment will need to be purchased. It may also take some time for the company to generate profits. During this time, running costs (insurance, chamber con­tri­bu­tions, etc.) must be covered.

Liability is the one major weakness of the sole pro­pri­etor­ship structure. The owner is fully liable with both their company and private assets. This includes real estate, vehicles, and valuables like jewelry, works of art, and so on. All this can be pledged up to the value limit set out in the law if the company becomes insolvent.

It is therefore important to be aware of all business risks before setting up the business. If there is a high en­tre­pre­neur­ial risk, a structure like a limited company may be more suitable. If you still opt for a sole pro­pri­etor­ship, it is important to protect yourself from in­sol­ven­cy by taking out ad­di­tion­al insurance.

Each in­di­vid­ual con­trac­tor is obliged to provide the tax office with an overview of the income and ex­pen­di­ture at the end of the financial year, which serves as the basis for the future tax treatment of the company. For small busi­ness­es and free­lancers, simple record-keeping is suf­fi­cient. This is included in your annual tax return. In contrast, larger companies are required to keep double-entry ac­count­ing records.

After reg­is­ter­ing your business with the Internal Revenue Service (IRS), you will be required to pay taxes on your in­di­vid­ual earnings through a regular tax return, rather than paying taxes directly on the business. This is known as “flow-through” taxation. In your tax return, you will be required to pay self-em­ploy­ment tax and income tax.

A sole pro­pri­etor­ship can be dissolved as quickly as it can be set up. For this purpose, business assets have to be trans­ferred to private assets, i.e. trans­ferred from the company to the private account. The IRS and state tax au­thor­i­ties need to be informed of the business’s ter­mi­na­tion. If you are reg­is­tered with your local Secretary of State, you must ensure that your entry in their register is removed.

• Foun­da­tion: Only possible by an in­di­vid­ual
• Company name: Name of the founder, plus possible addition
• Seed capital: Not required by law
• Liability: Unlimited (with both business and private assets)
• Reg­is­tra­tions: IRS, state tax au­thor­i­ties, Secretary of State
• Ac­count­ing re­quire­ments: single-entry book­keep­ing is suf­fi­cient
• Tax oblig­a­tions: Income and self-em­ploy­ment filed through an in­di­vid­ual tax return
• Dis­so­lu­tion: Business assets are converted into private assets and the tax office is informed

The biggest advantage of setting up a sole pro­pri­etor­ship is certainly that no seed capital is required. In addition, there are rel­a­tive­ly small bu­reau­crat­ic hurdles. Sole pro­pri­etor­ships only have to register with their state and federal tax au­thor­i­ties, and register their name with the Secretary of State should they choose a name other than their own for the business. This means that the cost of setting up a sole pro­pri­etor­ship is very man­age­able.

However, all these ad­van­tages come with a major dis­ad­van­tage: unlimited liability. This means that the owner is liable with all their assets, including private ones. For this reason, a founder should carefully consider whether their business idea involves increased en­tre­pre­neur­ial risk. If that is the case, opting for a company with limited liability may be prefer­able.

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