Are You Automatically A Sole Proprietor When You Start A Business?

I see all you small business owners out there trying to figure out the ins and outs of the legality of your businesses. You see terms all the time like LLC and sole proprietor, but what exactly do they mean, how and where does your business fit, and what do you have to do to make sure your business is legally formed? You may not know this but most small businesses start as a sole proprietorship, whether you choose it or not. So what does this mean for your business? Let’s dive in and find out. 

What Is a Sole Proprietor?

A sole proprietorship is a business structure that does not separate assets and liabilities from you as the owner. That means YOU are responsible for debts, incurred costs, and other obligations of your business and can be personally liable for any issues that arise. Your business is not a separate entity but rather you as the business owner are personally responsible for it.

Being a sole proprietor is the default business formation for tax purposes, which means you are automatically a sole proprietor when you start your business and don’t have to file or register with the state in order to become a sole proprietor (like you would if you wanted your business as an LLC). This is a great place to start if you are just beginning your business, or are the only one at your company since with this type of formation there is less formality and obligation to maintain your legal status.

If you have more questions about what happens when you begin your small business I HIGHLY recommend visiting the Small Business Administration’s website to learn more about business structures and formation. 

What Are The Benefits and Drawbacks of Being a Sole Proprietor?

If you are a sole proprietor, you can always choose to form your business another way, such as into a limited liability company (or LLC). So make sure to explore the pros and cons to choosing to stay as a sole proprietor. 

Pros:

• There is very little work to establish a business as a sole proprietorship (In fact, many people are sole proprietors without realizing it!)
• It's an automatic status that does not require you to register with the state, file an annual report, or pay a fee to maintain your legal status.
  
  

• Taxes are simpler
• You and your business are one in the same, you can easily claim your business income/losses on your regular individual tax form/return rather than having to file separately. 
  
  

• There are no annual or startup fees to establish your business.

Cons:

• Personal Liability
• Any debt, costs, etc., COULD be taken from your personal assets/savings. Your credit can be affected if you default on a loan. You can be liable for any lawsuits that can arise.
  
  
• It can be harder to get a loan from banks
• Many banks will be less likely to provide loans to Sole proprietor versus LLC
  
  

• Though you do not need to register with your state, you are still required to abide by your personal state’s regulations for the business you are conducting.

What Should You Choose?

In order to choose the proper business structure, you should consider where you want your business to go. If you want to remain as a one-person business and are not facing liabilities or dealing with larger assets, you may choose to stay as a sole proprietor. This will allow you to not worry about registering with the state, stress over different tax forms, or think about yearly business entity filings. If you want to expand to a couple employees or reach a larger group of customers whereby your liabilities and risks increase, it may be better to form your business as an LLC instead to limit personal liability and separate debt from your personal assets. It is completely up to you and how you want to proceed. However, make sure you know the positives, negatives, and what that means for your small business!

Learn how to sign your contracts as a Sole Prop HERE.