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Sole Proprietorship
It is common to hear words like company, corporate, firm, and organisation in business terminology. While starting a business or expanding an existing one, we need to decide what type of organisation or firm we want. There are various forms of business organisations ranging from a one-person company to a company with several owners. One such form of organisation is the sole proprietorship.
What is a Sole Proprietorship?
A sole proprietorship is quite a popular form of business. As evident from the term itself, it refers to an organisation that is owned, managed and controlled by a single individual who is the recipient of all profits and bearer of all risks. Also referred to as a sole trader or proprietorship, it has just one owner who pays personal income tax on profits earned from the business. This form of ownership is perfect for those individuals who are starting a business of their own (for example, an entrepreneur) or for a business in its initial years.
The simplicity of this form of business makes it an attractive choice in today’s fast-moving world. With the global barriers to trade and business breaking down, the emergence of small businesses and startups have taken the front seat in development.
How is Sole Proprietorship different from a corporation?
As the word “sole” means only and “proprietor” means owner, a sole proprietor is the one and only owner of the business. Hence, a sole proprietorship differs from a limited liability company (LLC) or a limited liability partnership ( LLP). There is no creation of a separate legal entity under sole proprietorship. In other words, the identity of the owner or the sole proprietor coincides with the business entity.
However, what begins as a sole proprietorship can be transformed into a more complex business structure (such as a corporation): If it grows substantially and can hire a large number of employees. For example, J. Willard Marriott famously started a root beer stand as a sole proprietorship that eventually became the A&W restaurant chain. He did this before eventually forming the Marriott hotel chain in 1957.
Real-Life Examples
With an increased number of startups and small businesses coming up in recent years, especially after the pandemic, sole proprietorship has proven to be a popular type of organisation. From startup founders to freelancers, everyone seems to be adapting to it. For example, startups like Nykaa also started as sole proprietorships.
In India, it is considered one of the most common types of business structure. Your neighbourhood chemist, grocer and shopkeeper all can be regarded as sole proprietors.
Merits and Demerits of Sole Proprietorship
Merits | Demerits |
Inexpensive: Setting up a sole proprietorship is generally considered an easy and inexpensive process. Although, the process can vary depending on the nation and the rules and regulations in place. However, in all cases, the process requires minimum or no fees. With a sole proprietorship, one does not need to fill out a tremendous amount of paperwork. | Unlimited liability of the owner: One of the most significant disadvantages of a sole proprietorship is the owner’s unlimited liability. As a separate legal entity is not created, unlimited liability is faced by the business owner for all debts incurred by the entity. Hence, if a business is unable to meet its financial obligations, creditors can seek repayment from the entity’s owner, even if they have to use their personal assets to repay outstanding debts. |
Few government regulations: Sole proprietors need to adhere to very few regulatory requirements. Unlike corporations, sole proprietorships do not need to spend time and resources on various government requirements. | Limited Capital: Unlike in the case of other corporations, sole proprietorships have relatively fewer options to raise capital. One instance is that the owner cannot sell business equity to obtain new funds. Moreover, the ability to obtain loans depends on the owner’s personal credit history. Hence, owners cannot use established channels, such as issuing equity and securing bank loans or lines of credit. |
Tax advantages: The sole proprietor is taxed only once, i.e. the owner only needs to pay personal income tax on the profits earned by the business. This is in stark comparison to corporations and other legal entities. | Lack of financial control: As financial statements are not required in a sole proprietorship, a lack of financial control is quite probable. The sole proprietor is not obligated to maintain financial statements and company minutes. This might ease processes, but a lack of accounting controls can result in the owner being lax about financial matters, such as falling behind in payments or not getting paid on time. |
Conclusion
As the oldest form of business organisation, a sole proprietorship is one of the most common choices considered while starting a business. Sole proprietorship, in simple words, is a one-person business organisation where a sole proprietor is a natural person and not a legal person/entity who wholly owns and manages this type of entity. According to J.L Hansen, “Sole trader is a type of business unit where a person is solely responsible for providing the capital, for bearing the risk of the enterprise and for the management of the business.”
