Meaning of the company’s business structure should never be underestimated as it has direct influence on many important business decisions. Legal structure of the company determines the amount of taxes to be paid, a person who would take an ownership of business debts and how easy investors and partners can join the business.
Entrepreneurs can choose among several business structure options, such as sole proprietorship, partnership, C-corporation or Limited Liability Company. The simplest and the least expensive form of business organization for the small business is a sole proprietorship. “Common proprietorship structures include part-time businesses, direct sellers, new start-ups, contractors, and consultants”.
There are many pros and some cons related to the sole proprietorship. Many individual entrepreneurs choose this organizational type because of the ability to avoid double taxation. In this case they report business related income on a personal income tax return form and get both lower tax rate and easier tax reporting in comparison with a C- corporation or Limited Liability Company. Sole proprietors are also allowed to include their business losses to a personal tax return. Thus they can reduce their personal tax obligations. Additionally, a sole proprietor doesn’t have to pay unemployment tax on himself or herself.
Another advantage for sole proprietors is minimal organizational and operational costs. An entrepreneur himself or herself can be an only employee in his/her business and there will be no additional expenses on wages and insurance. The business can operate either under some fictitious name or under the real name of its owner; consequently the expenses on registering a legal entity or a trademark are absent. All is needed to do in the first case is to register a trade name or fill the company name.
However, a sole proprietorship despite all its advantages is far from being a perfect organizational type for every small start-up business. There are some disadvantages to consider before making a decision. The main downside of a sole proprietorship is unlimited personal liability of the business owner for all debts and losses of the business. It means that if a sole proprietor operates high risk business and his/her business funds are insufficient to cover any debts, bank loans, liability claims, he/she would have to pay business costs from his/her own finances and property. It may also mean that entrepreneur, who shares bank account with a spouse, can potentially lose all the assets they have ever owned as a married couple. If an unlimited personal liability is a crucial factor for the entrepreneur, it may be better to choose between corporation and Limited Liability Company.
Another downside of a sole proprietorship is inability to raise business capital by selling a share or an interest in the business. As a rule, professional investors choose corporations due to many shareholders and the flexibility in issuing shares. Entrepreneurs who ever planned to make the company public and to take it to the stock exchange, should consider organizing a C-corporation as well.
As a sole proprietor, entrepreneur is responsible for all business related decisions, problems and results. Not anybody can work alone under no supervision and to be productive. In some cases bringing a partner into a small business can be a good idea. It can also increase start-up capital and potentially resolve a problem with financial accounting.
Summarizing all the above, one can conclude that the choice of most suitable business organization structure depends on several factors, such as type of business, risks and liability, amount of start-up capital, long time business development plans, number of employees, tax rates etc. The choice of business structure may have both personal and legal consequences. Sole proprietorship is most popular for start-ups and small businesses that can be further developed to more complex business forms. As any other business type, sole proprietorship has its advantages and disadvantages. It may be a good choice for the individuals who are independent, ready to take a risk and responsibility for all business decisions.