Financing Sole Proprietorships
A sole proprietorship is a single-owner business and the simplest form of
business entity. However, a sole proprietorship is also the most restrictive
form of organization for equity financing because the equity investment is
limited to whatever personal funds you are willing to put into the business.
Those funds may be already available in your personal financial portfolio —
from simple savings accounts at banks to ownership of commercial real estate —
or you may need to borrow more money and contribute those funds as an equity
investment in your business. Debt financing for
startup sole proprietorships is also typically limited by the amount of personal
assets that the entrepreneur has available to pledge as security for a loan.
Among the advantages of a sole proprietorship are:
- Exclusive control: you retain sole control over the management and
development of your business.
- Cheap and easy to form and maintain: almost no formalities are required to
create a sole proprietorship (unless certain licenses are necessary for that
type of business) and the administrative costs are minimal. Most states do
require that if you operate your business under any name that is not your
personal name, you need to file, in the local county where you will do
business, a certificate that identifies you as the owner of that business.
This certificate allows creditors to locate the people legally responsible
for the business's affairs.
- Simple (and often favorable) tax
treatment : all income and expenses of the business are included on your
personal tax return, usually on Schedule C. In addition, because startup
businesses often operate at a loss during an initial period, the losses can
be deducted on your personal tax return to offset income you earn from other
sources.
Disadvantages of a sole proprietorship include:
- Personal liability: your business is not a separate legal entity and all
business debts and liabilities are your personal obligations. You are
personally responsible for the business's contracts, taxes, and the
misconduct of employees or co-owners who create legal liabilities while
acting within their employment. Although personal liability is a risk for
sole proprietors, several considerations should be kept in mind. First,
insurance may be available to minimize the effects of personal exposure for
some of these liabilities. In addition, personal liability for business contracts
is common in any form of small business — the situation is not necessarily
worse for sole proprietors. To minimize the risks associated with small
businesses, customers, landlords, suppliers, and others will often require
that the owner assume personal responsibility (sign a personal guarantee)
for the business's contract, regardless of the form of your business
enterprise.
- Limited financing options: the financing profile of a sole proprietorship
is limited to the credit profile of the individual entrepreneur. If you are
unwilling, or unable, to sell off any ownership interests in your business,
you are the sole source of available equity financing. You may also have a
difficult time obtaining debt financing, except to the extent you can pledge
personal assets on a secured loan
.