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Sole proprietorships are the most common business structures. That’s because it’s the easiest way to get your business up and running. A sole proprietorship offers an easy and affordable way to start a business. With a sole proprietorship, you and the business are considered as one legal entity making you personally liable for business debts and lawsuits.
- If you are just starting out and are testing the waters with your idea, a sole proprietorship is the way to go.
- It is easy to set up and easy to dissolve if your idea doesn't work out or you come up with a better one.
How to Start a Sole Proprietorship
The first thing to realize is that no formal action is required. If you are the only business owner, the sole proprietorship is officially open whenever you start business activities.
However, most sole proprietors take a couple of steps to get their business rolling. We will cover them below.
Step One: Make Sure a Sole Proprietorship is Right for You
First things first, you need to research different business structures. Although a sole proprietorship is a common choice, it’s not the best option for everyone.
Here are a few other structures to consider:
- Partnership: If you are going into business with someone else, then a partnership is a relatively simple in-between option.
- Limited Liability Company (LLC): An LLC creates a separate legal entity that protects your personal assets. You might like to learn more about the differences between LLC and sole proprietorship in our article.
- S Corp: An S Corp is an LLC with a particular tax status. S Corps require flow through tax treatment, whereas LLC’s can elect S or C corp treatment (flow through or separate taxation), and S corps are limited to 100 owners. See: S Corp vs. sole proprietorship for in-depth information.
Step Two: Choose a Business Name
You can choose to operate under your own name as a sole proprietor. But many business owners choose a separate name for their business.
- Brainstorm: The first name you come up with for your business might not be the best one. Instead, sit down for a brainstorming session to develop several options.
- Check availability: Most states have a name check tool available through their business filing agency. Take some time to see what options are still available. Also check for a domain name because you might want email and a website.
- Land on a name: The right name can draw in your customers. Make sure you pick a good one!
Step Three: Register Your Business Name
After you choose a business name (if you decide to operate with something other than your own name), you’ll need to establish this name.
- Doing Business As (DBA): As a sole proprietor, you can register your business name as a DBA or fictitious name. In most cases, you’ll file this paperwork with your state’s business filing agency.
- Pay a fee: In order to file this paperwork, you’ll usually have to pay a small fee.
Step Four: Purchase a Website Domain
A website is a hub for most businesses. So, it’s a good idea to purchase your website domain immediately.
- Try to get a website domain that matches your business name. Make it easy for customers to find you. If it’s not available, then it’s time to get creative.
- You don’t have to build out the website immediately: If you don’t have the time or resources to build out your business website, that’s okay! Simply buying the domain and holding onto it for later is a good idea.
Step Five: Acquire the Necessary Licenses and Permits
Even though you don’t have to file any paperwork to create your business, you’ll still need to acquire the necessary licenses and permits.
- Research your needs: The licenses and permits you need vary based on your location. Take the time to find out what’s required for your area.
- Budget appropriately: Many licenses and permits come with a fee attached. Be prepared to cover this cost.
Step Six: Obtain an Employer Identification Number (EIN)
As a sole proprietor, you aren’t required to get an EIN. But it’s usually a good idea. See: Does a sole proprietorship need an EIN for further details.
- EIN benefits: An EIN allows you to open a business bank account, hire employees, protect your Social Security Number, and more. If you are going to do work for the government you will need an EIN for most contracts. Many larger corporations will require you to have an EIN to work with them also.
- Get one from the IRS: You can obtain an EIN by filing an SS-4 form with the IRS.
Step Seven: Open a Business Bank Account
If you want to take your business seriously, then opening a business bank account is a must. A separate account allows you to easily keep your personal and business expenses separate.
- Easier to track your business income and expenses: Without your personal costs mixed in, you can more easily track your business’s profits. This is especially handy at tax time.
- Easier to obtain business loans. Without a separate account for your business, many lenders are unwilling to provide sole proprietors with business loans.
Step Eight: Get Insurance Coverage
Insurance coverage is a useful way to protect your business assets. Here are a few business insurance types to consider:
- Property and liability insurance: If you have a business that could be sued, then a property and liability insurance policy is a worthwhile expense. The coverage could prevent financial ruin in the event of a lawsuit in case someone is injured at your location.
- Business auto insurance: If you plan to use a vehicle for business purposes, then consider this type of insurance.
- Errors and Ommissions (E&O) Insurance: If you are a white collar professional (attorney, accountant, medical, finance, etc.), an E&O policy will protect you from professional mistakes.
Step Nine: Pay Your Taxes
Paying your taxes will look a bit different for sole proprietors.
- You must pay Social Security taxes: You are required to pay both the self-employment tax (SUTA) on your business income in addition to the FICA tax that an employee would normally pay (7.65% below the wage base) which works out to a total of 15.3%.
- You must pay income taxes: On top of your self-employment taxes, you’ll pay income taxes on the net profits.
- You must make estimated quarterly payments: You cannot wait until the end of the year to pay your taxes. Instead, the IRS requires estimated quarterly payments from sole proprietors.
Advantages of a Sole Proprietorship
A sole proprietorship comes with many advantages. Here’s a closer look at the benefits to expect.
Easy to Form
A sole proprietorship is generally considered the easiest type of business to start.
- No upfront or ongoing paperwork requirements: The sole proprietorship is open as soon as you start business activities.
- Permits and licenses still required: Depending on your business type, you may still need to acquire permits and licenses.
Uncomplicated Management Structure
The lack of paperwork translates into an uncomplicated management structure.
- Minimalistic business structure: You are completely in charge of the operation. Without any business partners or shareholders to report to, you can make decisions as you see fit.
Tax time is easier with a sole proprietorship.
- Pass-through taxation: The business owner will claim all of the business income on their personal tax return.
- No extra business tax filing: You don’t have to make an extra tax filing for your business.
Low Overhead Costs
The simple structure can lead to low overhead costs.
- No cost to start: Without a filing requirement, you don’t need to pay anything to get started.
- No ongoing filing costs: Other business structures require annual filings and fees to keep up with.
Disadvantages of a Sole Proprietorship
As with all business structures, there are some disadvantages to consider.
Unlimited liability is the biggest disadvantage of a sole proprietorship.
- Personally responsible: As a sole proprietorship, the owner is personally liable for all debts incurred and lawsuits against the business.
- Personal assets at risk: With this personal liability, your personal assets are at risk.
As a sole proprietor, you are completely responsible.
- Complete responsibility: With complete control comes complete responsibility.
- Tendency to overwork: Unlike an employee, you might not feel like you can clock out at the end of the day. This habit can lead to burnout.
The lack of separation between personal and business assets makes things unclear.
- Hard to get investments: Most investors aren’t willing to invest in a business that’s not its own legal entity.
- Client questions: Some clients won’t take you seriously as an unincorporated business.
Difficulty Raising Capital
When the line between your personal and business assets is hazy, that can lead to funding issues.
- Lenders usually require a separate legal entity: Many lenders won’t provide a loan without a separate legal entity.
- Banks often require a separate legal entity: Some banks won’t allow you to open a business bank account as a sole proprietorship.
FAQs about Sole Proprietorships
Still have questions on how to become a sole proprietor? We have answers!