Sole Proprietorship

A sole proprietorship is a business that is owned (and usually operated) by one person. Sole proprietorship is the oldest and simplest form of business ownership, and it is the easiest to start. In most instances, the owner (the sole proprietor) simply decides that he or she is in business and begins operations. Some of the largest of today's corporations, including Ford Motor Company, H.J. Heinz Company, and J.C. Penney Company, started out as tiny sole proprietorships.

There are more than twelve million sole proprietorships in the United States. They account for more than two-thirds of the country's business firms. Sole proprietorships are most common in the retailing, agriculture, and service industries. Thus the specialty clothing shop, comer grocery, and television repair shop down the street are likely to be sole proprietorships.

Most of the advantages and disadvantages of sole proprietorships arise from the two main characteristics of this form of ownership: simplicity and individual control.

Advantages of Sole Proprietorships

Ease and Low Cost of Formation and Dissolution No contracts, agreements, or other legal documents are required to start a sole proprietorship. Most are established without even an attorney. A state or city license may be required for certain types of businesses, such as restaurants or catering services, that are regulated in the interest of public safety. But beyond that, a sole proprietor does not pay any special start-up fees or taxes. Nor are there any minimum capital requirements.

If the enterprise does not succeed, or the owner decides to enter another line of business, the firm can be closed as easily as it was opened. Creditors must be paid, of course. But the owner does not have to go through any legal procedure before hanging up an "Out of Business" sign.

Retention of All Profits All profits earned by a sole proprietorship become the personal earnings of its owner. This provides the owner with a strong incentive to succeed—perhaps the strongest incentive—and a great deal of satisfaction when the business does succeed. It is this direct financial reward that attracts many entrepreneurs to the sole proprietorship form of business.

Flexibility The sole owner of a business is completely free to make decisions about the firm's operations. Without asking or waiting for anyone's approval, a sole proprietor can switch from retailing to wholesaling, move a shop's location, or open a new store and close an old one. A sole owner can also respond to changes in market conditions much more quickly than the operators of other forms of business. Suppose the sole owner of an appliance store finds that many customers now prefer to shop on Sunday afternoons. He or she can make an immediate change in business hours to take advantage of that information (provided that state laws allow such stores to open on Sunday). The manager of one store in a large corporate chain may have to seek the approval of numerous managers before making such a change.

Furthermore, a sole proprietor can quickly switch suppliers to take advantage of a lower price, whereas such a switch could take weeks in a more complex business.

Possible Tax Advantages The sole proprietorship's profits arc taxed as personal income of the owner. Thus a sole proprietorship does not pay the special state and federal income taxes that corporations pay. (As you will see later, the result of these special taxes is that a corporation's profits are taxed twice. A sole proprietorship's profits are taxed only once.) Also, recent changes in federal tax laws have resulted in higher tax rates for corporations than for individuals at certain income levels.

Secrecy Sole proprietors are not required by federal or state governments to publicly reveal their business plans, profits, or other vital facts. Therefore, competitors cannot get their hands on this information. Of course, sole proprietorships must report certain financial information on their personal tax forms, but that information is kept secret by taxing authorities.

Disadvantages of Sole Proprietorships

Unlimited Liability Unlimited liability is a legal concept that holds a sole proprietor personally responsible for all the debts of his or her business. This means there is no legal difference between the debts of the business and the debts of the proprietor. If the business fails, the owner's personal property—including house, savings, and other assets—can be seized (and sold if necessary) to pay creditors.

Unlimited liability is thus the other side of the owncr-kecps-the-profits coin. It is perhaps the major factor that tends to discourage would-be entrepreneurs from using this form of business organization.

Lack of Continuity Legally, the sole proprietor is the business. If the owner dies or is declared legally incompetent, the business essentially ceases to exist. In many cases, however, the owner's heirs take over the business and continue to operate it, especially if it is a profitable enterprise.

Limited Ability to Borrow Banks and other lenders are usually unwilling to lend large sums to sole proprietorships. Only one person—the sole proprietor—can be held responsible for repaying such loans, and the assets of most sole proprietors are fairly limited. Moreover, these assets may already have been used as the basis for personal borrowing (a mortgage loan or car loan) or for short-term credit from suppliers. Lenders also worry about the lack of continuity of sole proprietorships'. Who will repay a loan if the sole proprietor is incapacitated?

The limited ability to borrow can keep a sole proprietorship from growing. It is the main reason why many business owners change from the sole proprietorship to some other ownership form when they need relatively large amounts of capital.

Limited Business Skills and Knowledge Managers perform a variety of functions (including planning, organizing, and controlling) in such areas as finance, marketing, human resources management, and operations. Often the sole proprietor is also the sole manager—in addition to being a salesperson, buyer, accountant, and, on occasion, janitor.

Even the most experienced business owner is unlikely to have expertise in all these areas. Consequently, the business can suffer in the areas in which the owner is less knowledgeable, unless he or she obtains the necessary expertise by hiring assistants or consultants.

Lack of Opportunity for Employees The sole proprietor may find it hard to attract and keep competent help. Potential employees may feel that there is no room for advancement in a firm whose owner assumes all managerial responsibilities. And when those who are hired are ready to take on added responsibility, they may find that the only way to do so is to quit the sole proprietorship and either work for a larger firm or start up their own business.