The day you start acting as a business, you become a sole proprietor. It’s that simple.
And while fast growth and certain higher liability types of businesses might make you want to consider other legal structures for your company, some types of enterprises are suited for sole proprietorship in the near and long term.
Here’s how to determine whether becoming a sole proprietorship is appropriate for your company, and how to go about doing it.
Understand the simplicity of it
Sole proprietorship is the simplest form of business entity. It means that you just hang your shingle – literally, figuratively, or both – and go about building your business with little practical effect on what you do. And as long as you’re the only owner of the business, you can continue operating as a sole proprietor.
“If you decide to cut lawns and get a truck and call yourself Rob’s Lawn Service, you’ve set yourself up as a sole proprietorship without really doing anything formal,” says Rob Markworth, partner in the Shanahan Law Group, a Raleigh, N.C., business-law firm. “The truth is that you sort of set up a sole proprietorship by default.”
Register your company with the state
Establishing a sole proprietorship is cheap and uncomplicated, but there is one legal procedure you might have to complete: registering your company with the state, usually through the county in which you live. It only costs a few dollars, though the specific cost varies by state.
You’ll need to register if you’re going to do business under an assumed name or a fictitious name; if you’re Bill Barnes, opening as Barnes Art Studio, for example.
This serves at least two purposes. First, it helps people who deal with your business understand who the real owner is. Second, in the process of registering your business, you will find out if you must obtain a business license to operate under state laws or local ordinances.
Realize that you and your company are “one”
From several important perspectives, there is no separating you from your company under a sole proprietorship. Legally, for example, you are one thing.
And when it comes to income taxes, you and your sole proprietorship are treated as a single entity. You report business income and losses on Schedule C of your own federal tax return, Form 1040, and your company’s and your personal financial streams are inseparable.
That also means, for tax purposes, that your spouse is “part” of the business even if he or she has nothing to do with it. And only your spouse can be considered a co-sole proprietor. If any other family member shares ownership with you, the business must be organized as a partnership, corporation or limited liability company.
Consider the importance of legal protection
Many entrepreneurs decide to form a different kind of legal structure for their businesses, either right away or over the long term, in order to protect them individually from liability claims. If someone sues your sole proprietorship, you’re legally naked: both your personal and business assets are threatened. And for that reason alone, many experts advise forming a limited liability corporation (LLC) or other business entity, which would grant you some protection from potential liabilities.
Of course, the amount of risk in remaining a sole proprietorship varies widely depending on what type of business you’re in, and you will want to take that into consideration before you decide to undertake even the relatively small cost and trouble of forming an LLC or other structure.
“If you were selling dynamite, you wouldn’t want to remain a sole proprietorship, for example,” says Jim Adams, partner with Gardere Wynne Sewell, a Dallas-based business-law firm. “But if you were, say, a personal shopper for businesswomen and businessmen – how are you really going to have much liability there? The chances of a problem are pretty remote. And the vast majority of businesses are in between those two extremes in terms of the liability risks of being a sole proprietor.”
Our Bottom Line
You become the sole proprietor of your business by default, the day you set up shop. But you should actively ponder your business structure and then decide if remaining a sole proprietor is still the best vehicle for you.