Sole Proprietorship Advantages and Disadvantages
You’re embarking on a new venture—that’s awesome! As a business owner, you may be wondering about sole proprietorships, particularly when starting out. Finding the key information you need can be a hassle. We’re here to help you answer those questions.
What is a sole proprietorship?
A sole proprietorship is the simplest business structure. There is a single owner of an unincorporated business who takes on all the responsibilities, including profits and debts, of that company. This is the primary difference from corporations.
Advantages of a sole proprietorship
1. Affordable and simple
The advantages of a sole proprietorship are simplicity and affordability, particularly when registering with Ownr. But, there are a few things you need to decide before you register as a sole proprietor.
2. You have freedom and flexibility
Freedom and flexibility of running your business as a sole proprietorship are included in this business structure. The process of registering as a corporation is longer and costlier, and business operations as an incorporated business are also more complicated.
As a sole proprietor, you aren’t restricted to complicated and strict regulations. This is particularly attractive to small proprietors who don’t have the labour to continually ensure these strict guidelines are adhered to and carry them out. Sole proprietors also have all the decision-making freedom.
3. Less paperwork
No business owner wants extra paperwork, so some people prefer to register as a sole proprietorship rather than incorporate their business. With incorporation, it’s mandatory to file yearly documentation. With less paperwork also comes less overhead costs of a bookkeeper who is familiar with the legalities of incorporation and securities laws.
Simply put, less paperwork means you can spend more time developing your unique business strategy to help prevent any hiccups down the road.
4. Simpler income tax
Taxes as a sole proprietorship (also considered self-employment taxes) are a lot simpler. As a sole proprietor, there are certain tax advantages that come with small business deductions.
For a small business that uses their own home as a business base, part of housing costs, including utilities, internet, and such, can be written off. This helps reduce personal taxes and possibly even result in a tax refund when you file your personal tax return. You don’t get this advantage with corporations.
5. Say hello to lower business fees
Fees for registering as a sole proprietorship business structure are decidedly lower when compared to an incorporated business, which is among the most attractive advantages.
As a sole proprietor, you and your business are not separate legal identities and in some cases, registering your sole proprietorship business is not necessary. However, if you use a different name than your personal legal name for your proprietorship business, registration is necessary.
Many sole proprietors choose to register their business name regardless of their regional requirements to put the most professional foot forward possible.
6. Straightforward banking
Just like taxes, dealing with complicated banking is a hassle. The beautiful thing about this form of business is banking simplicity. You can choose to keep your personal chequing account as your business account, but you may kick yourself at tax time when you have to separate expenses. In this case, it’s advisable to open a separate business bank account. This can be done quite easily, inexpensively, and even online!
How’s that for straightforward?
7. Simplified ownership
A sole proprietorship is as simple as it gets in terms of business structure. It’s a single owner making the decisions, taking responsibility, and controlling all aspects of the business. For many small business owners, this is ideal as there isn’t the risk of discord between owners of corporations or partnerships. Simply put, a sole proprietor isn’t at risk of losing control.
Disadvantages of sole proprietorship
1. No liability protection
Among the drawbacks of this type of business entity is personal liability. You are solely responsible for all the financial aspects of your business. This means all debts and any litigation fall on your shoulders. This puts your own money at risk as your personal assets are exposed. In this case, having separate business insurance is a good idea.
This is among the primary differences between sole proprietorship and incorporation that can be concerning. With incorporation, there is a limited liability that rests solely on the business as a legal entity.
2. Financing and business credit is harder to procure
As a business entity, you may have a harder time securing financing and business credit than a corporation. An incorporated business is eligible for government funding and can raise funds fairly easily. A sole proprietorship generally can’t. Part of the reason for this is because an incorporated business has a legal distinction that a sole proprietor doesn’t.
3. Selling is a challenge
Sole proprietors may not want to consider the possibility of selling their business. As a business owner, contemplating passing the baton is not something many want to think about, but practically, it’s important to take this into consideration.
Sole proprietorships are harder to sell than a corporation. If your business has significant profits, then the sale of the business will trigger capital gains tax. This is the tax on the gains from the purchase or initial start of the business to the date of the sale and can run upwards to 49 per cent of the total gains. For a sole proprietor, this can be tough to swallow.
The sale of a sole proprietorship also means the sale of debts. Newer businesses might carry debt that outweighs profit, particularly when first starting up. While this may be a normal thing, it can be difficult to forecast future profits for potential buyers.
Because many sole proprietorships are small businesses and come with a particular amount of personal connection, this can cause certain feelings to arise and possibly cloud your judgment.
4. Unlimited liability
Among one of the biggest disadvantages of a sole proprietorship is unlimited liability. This liability not only spans the business but the business owner’s personal assets. Debt collectors can access your savings, property, cars, and more to see a debt repaid. When you register your business, it’s important to look into insurance as a precaution.
5. Raising capital can be challenging
While sole proprietorship startup costs are low, difficulty raising capital can limit growth and possibly even run you in the red for a little while. Because you’re personally liable for business debts, it’s also your responsibility to foot the bill for suppliers, overhead and labour costs, and so on. This is one of the significant disadvantages of sole proprietorships as business owners’ personal assets are limited or tied up in the business.
6. Lack of financial control and difficulty tracking expenses
Because financial reports aren’t usually required as a regular part of doing business and one person plays the role of accountant, manager, marketer, and strategist all in one, sole proprietors sometimes find themselves letting financial business transactions slide. This can cause a significant lack of financial control and risk blending these transactions with personal income, making keeping track of expenses a challenge. In these cases, profits and losses can go unaccounted for, and tax time will be even more difficult.
Requirements for sole proprietorships in different provinces
Ontario, Alberta, and B.C. have slightly different registration process requirements for sole proprietorships and generally require you to fill out a form and pay a nominal fee.
In Ontario, it’s not necessary to have a legal name separate from your own name. If you do decide to use a different name, make sure legal identifiers like Inc., or Corp. are not included. If you are using your own personal name, registering is not necessary, only if you separate legal names.
Alberta is very similar as you need proof that you are not associated with any partnerships or that anyone else is using the same name. In Alberta, you must also register a Declaration of Trade Name. In both Ontario and Alberta you can use a NUANS search to check similar business names already being used, but it is not a requirement to do so. In B.C. a name search is required for a sole proprietorship, and you can provide three different name choices.
Why is it important to incorporate a business?
You might find yourself in the position that the disadvantages outweigh the benefits for you, making the transition to incorporate your business an easy one. As your company becomes a separate legal entity, this means limited liability and easier access to funding. For startups, this can be the difference between success and closing down shop. Put simply; there are a lot of advantages to incorporating your business. This also includes incorporating a cooperative.
Whether you are thinking of incorporating or registering a sole proprietorship, Ownr can help.
This article offers general information only and is not intended as legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. While the information presented is believed to be factual and current, its accuracy is not guaranteed and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author(s) as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or its affiliates.