Sole Proprietorship

What It Means

A sole proprietorship is a business that has only one owner. It is the simplest and most common form of commercial enterprise in the United States. A sole proprietor with a license may hire employees and run any sort of lawful business, the most common sole proprietorships being in the areas of food service, home maintenance and improvement (roofers, electricians, and cabinet makers, for example), auto repair, and child care. The greatest advantage of running a sole proprietorship is the autonomy, or self-direction. Unlike in a corporation or a partnership, a sole proprietor need not consult with anyone else before making important decisions about running a business. Of course, the sole proprietor also bears the full burden of the consequences of those decisions.

The greatest disadvantage to operating a business as a sole proprietorship is the extent of liability (financial responsibility). A sole proprietor is completely liable for all debts incurred and damages caused in the process of doing business. For example, if one of the employees of a sole proprietor injures a client or damages property while on the job, the sole proprietor must pay for all monetary losses. If the proprietor’s insurance does not cover the damages, the courts may demand that the sole proprietor liquidate (sell or convert into cash) personal assets to pay for the losses or the harm done. If there are still outstanding damages, the sole proprietor will then be forced to file for bankruptcy (financial ruin).

When Did It Begin

Running a sole proprietorship is one of the oldest ways of doing business in the world. It is also the riskiest form of business venture. At least as far back as ancient Greece, individual entrepreneurs (people who start businesses) have recognized the need to combine resources with others in order to minimize risk and maximize profit. Many modern businesses trace their roots to the joint stock companies that formed in the early 1600s when European countries expanded their overseas trading and colonizing efforts. A joint stock company consisted of a group of members, each of whom contributed money to the business. Members were given certificates of ownership, or stocks, in exchange for their contributions. These commercial organizations searched for legal ways to limit the liability of individual members. The problem remained largely unsolved for nearly three centuries, however, until a court handed down the Salomon v. Salomon and Company verdict in England in 1896. Deciding on a seemingly small case involving a leather merchant, the House of Lords voted unanimously to recognize a company as a separate legal identity, distinct from its owner(s). This ruling gave a significant advantage to people doing business as a corporation rather than as a sole proprietorship, in which there is no legal distinction between the business and the owner of the business. In the following century a series of corporation-friendly laws were passed in many other nations, including the United States.

More Detailed Information

The majority of businesses begin as sole proprietorships. One reason for this is that starting a sole proprietorship involves few steps. In fact, after getting the appropriate licensing for a given task (an electrician, for example needs to be licensed and certified in order to open an electrical repair shop), a business is automatically considered a sole proprietorship unless the owner takes specific steps to classify it some other way (for instance, as a partnership or a corporation). Most sole proprietors follow the easiest course and do business under their own names. A mechanic running his own garage may call his business Bill Jones Auto Repair without further paperwork. If an owner wishes to use a trade name, or what is often referred to as a fictitious name, he or she must file a trade name certificate in the city, county, or state in which the establishment is based. Going back to the above example, if Bill Jones wished to call his business Superstar Auto Repair or even Bill’s Auto Repair, he would have to file such a certificate. Bill Jones would only be permitted to use one of these trade names if no other businesses had been previously registered under these names.

A sole proprietorship terminates with the death of the sole proprietor. If a spouse or relative continues operating the business after the death of the proprietor, the business is legally considered a different establishment. Sole proprietorships are also terminated when they are sold or when the owner goes bankrupt.

Aside from autonomy, owners of sole proprietorships enjoy two key benefits at tax time. First, the owner can use a personal 1040 tax form (the form all individuals and families use) to pay taxes or file for a tax refund. This form is much simpler than the ones required of a partnership or corporation. Second and more important, the owner is only taxed once on all profits. This is not the case in a corporation, where the business is first taxed as a single entity, and then shareholders (people who invested money in the business) are personally taxed on all dividends (shares of the profits). This possible financial benefit must be weighed against other limitations and challenges. Sole proprietors, for example, frequently have a more difficult time raising money to start or expand their business and securing loans than corporations do.

The flexibility and autonomy of running a sole proprietorship come with some other negatives. Chief among them is the fact that the sole proprietor must be skilled in all aspects of the business. In the example above Bill Jones probably started his auto repair shop because he is a talented mechanic. In order to succeed, however, he must also be able to market (find customers for) his business and organize his account books (recording payments made to him, expenses, and so forth). If he does not have the time or the inclination to look after these things carefully, he will have to hire someone else to manage these tasks. A sole proprietor may have a harder time than a corporation in finding good, long-term help, because corporations can often afford to offer many more benefits (such as health care and vacation pay) to employees.

Recent Trends

Woman-owned sole proprietorships are one of the fastest growing forms of business in the United States. In terms of number of businesses and profit totals, female-owned sole proprietorships have been growing faster than their male-run counterparts for more than two decades.

According to the U.S. Small Business Administration nearly 85 percent of all the businesses run by women operate as sole proprietorships. These businesses tend to make moderate rather than large profits. Data from the mid-1990s through 2006 indicate that approximately 87 percent of woman-run sole proprietorships earned $50,000 per year or less, while about 2.7 percent of female-run sole proprietorships earned $200,000 or more. Nearly 75 percent of the women’s businesses are based in the service industries, such as day care and catering, and another 18 percent are in finance and insurance. More than half of the female sole proprietors in the United States run their businesses in one of the country’s top 10 urban centers. By contrast less than one-third of the male-run sole proprietorships are based in urban centers.