A sole proprietorship is usually the type of business entity many new entrepreneurs form. It’s very easy to start a sole proprietorship which is why so many entrepreneurs begin there. However, before launching business operations, it’s important to know and understand the different types of business entities that you can form. Knowing and understanding how they all work will help you make a more informed decision when registering your company. In this blog discuss the advantages and disadvantages of a sole proprietorship and other business entity types like a limited liability company and corporation. I also discuss the importance of choosing the right business structure if you plan on applying for small business financing to fund your business.
Definition of a Sole Proprietorship & an Example of a Sole Proprietor
A sole proprietorship is a business that isn’t separate legal entity from the person that owns and runs it (i.e. the sole owner). In the eyes of the law the business and the person are one in the same. A good example of a sole proprietor is someone who starts a home-based business selling information products online. The person may simply register a dba name for the business (in their state) and start operating. That’s it. When the person files their personal tax return, they report their business income and profit or loss. The business income and profit or loss is reported on IRS (Internal Revenue Service) form 1040 – Schedule C. The person is responsible for paying a self-employment tax for any income earned from the business. In addition, the sole proprietor is personally liable for all company debt incurred.
Advantages of a Sole Proprietorship
The biggest advantage of a sole proprietor business is the fact that it is very easy to setup. In most states you can register a dba name for the business and start operating immediately. (Depending on your industry, you may also need to obtain the appropriate licensing and insurance to legally operate in your state). There’s not much paperwork or waiting time when registering a proprietorship business. It can also be inexpensive to set it up (depending on the state). This is likely why entrepreneurs who are just getting started setup this type of business entity. This is where the advantages of a sole proprietor business begin and end. The disadvantages seem to be greater.
Disadvantages of Sole Proprietorship
The biggest disadvantage of a sole proprietor business is that fact that you are personally liable for any business debts your company incurs. For example, if you purchase supplies for the business and don’t pay the supplier, it could negatively affect your personal credit. Even though the supplies are for your business, you and the business are one in the same therefore you are personally liable for the debt. If the supplier sues you for the money and you don’t have it, you could be putting your personal assets at risk. Your personal assets can be seized for business debts you fail to pay under a sole proprietorship.
The Best Business Structure for Entrepreneurs in Need of Funding?
If you’re planning on obtaining capital via a bank, lender or investor, it would be wise to register a limited liability company (LLC) or a corporation. Limited liability companies and corporations look much more legitimate than a sole proprietor business. This is especially true for businesses in certain industries. Several good examples would be car dealerships or construction companies. It may be okay for a home-based business to be formed as a sole proprietorship. However, it may not make any sense for a high-tech company to be formed as a sole proprietorship. It all depends on what type of business is being built, the business industry and the goals of the business owner.
An LLC or Corporation is the Best, Period!
The bottom line is that LLCs and corporations provide greater protection for the owner. The owner is not personally liable for the business debts under an LLC or corporation. It is recommended that entrepreneurs in need of funding register an LLC or corporation to protect themselves from being personally liable for business debts. When you are just starting out, your chances of failure are the highest. Protect yourself from the debt liabilities that can come along with business failure. Form an LLC or corporation instead of a sole proprietorship to protect yourself.
LenCred Can Help You Get Funding No Matter Your Business Structure
Even though I suggest you form an LLC or corporation before applying for any type of debt financing for your small business, LenCred can help you get funding no matter what business structure you use. In fact many of LenCred’s clients are startup business owners that own sole proprietorships. The LenCred team specializes in helping startup and established business owners obtain unsecured business lines of credit. Unsecured business lines of credit can be fairly simple for sole proprietors to obtain. The key to getting approved for an unsecured business line of credit is not related the business structure you use. It’s based on your personal credit history. No matter what business structure you use for your company, as long as you meet the credit requirements, your chances of getting approved for an unsecured business line of credit to fund your business are great.
Upgrade from a Sole Proprietorship to an LLC or Corporation
The first client I referred to LenCred was a sole proprietor that owned an internet based home business. He was able to obtain around $238,000 in unsecured business lines of credit for his sole proprietor business. I’m happy to say that the funding helped him a great deal and he is still operating his business today. However, he’s upgraded the business from a sole proprietorship to a limited liability company. He realized that a sole proprietorship was a good starting point but if he planned on building a long term, sustainable and profitable business it’s probably best to upgrade to an LLC or corporation so he’d never end up being personally liable for company debts.