What to Know About Investing in a Sole Proprietorship

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A sole proprietorship is an option to consider if you plan to start a new business or restructure your current venture.

Sole proprietors run their businesses without partners or external entities involved in daily operations, solely profiting from doing business. Still, you have several factors to consider before starting and investing in a sole proprietorship.

Below, we’ll define this business structure, discuss the advantages of operating it, and explore other considerations associated with sole proprietorships.

What is a Sole Proprietorship?

A sole proprietorship is a non-registered, unincorporated business operated by only one person. Unlike a limited liability company (LLC) or a corporation, the business and its owner are viewed as one entity.

As mentioned, sole proprietors take the revenue generated from their business activities. However, since there is no separation between the business and its owner, the latter handles all incurred debts, losses, and liabilities.

Many sole proprietors or traders operate their businesses under their legal names, but you can run a sole proprietorship using another name. Filing a DBA (“doing business as”) with your chosen state is one way to do so.

What are the Advantages of Sole Proprietorships?

• Simple and inexpensive to form: In most cases, you can establish sole proprietorships without submitting multiple documents to your state and waiting for its approval.
  • Starting these businesses also costs less than forming other business entities. Multiple fees go into LLC formation and incorporation, making them costlier to operate and maintain.
• Minimal regulatory requirements: Sole proprietors must conduct record-keeping and file and pay taxes with their state. Conversely, the laws and regulations applicable to bigger businesses are managed thoroughly, and sole proprietorships are exempt from these legal obligations.
• Full control over business operations: Another advantage of being a sole trader is managing all aspects of the business yourself. For this reason, most entrepreneurs choose sole proprietorships, as a successful business equates to a successful entrepreneur.
• Flow-through of generated profits: Sole traders receive all profits their businesses make. Moreover, they only pay taxes once and do so individually.
  • Sole proprietors are obligated to pay individual taxes periodically. However, state regulations may require regular tax payments over a fixed period.
• Simplified banking: Sole proprietorships don’t need business bank accounts. Personal accounts are enough for transactions, although record-keeping must be done to distinguish personal and business spending.

What’s the Difference Between a Business Owner & a Sole Proprietor?

The main difference between a business owner and a sole proprietor is the level of ownership associated with their chosen business structure.

You’re considered a business owner if you legally own a business venture. Some corporations are viewed as such because they own one or more businesses. In contrast, you’re called a sole proprietor if you operate as a sole proprietorship.

Can I Convert a Sole Proprietorship Into Another Business Structure?

If a sole proprietorship sees significant growth or needs restructuring, it can be converted into a different business structure.

Most of the time, small businesses with an uncomplicated structure become larger entities with added formalities. To indicate significant operational changes, you could also convert a corporation or LLC into a simpler legal entity; however, this rarely occurs.

Sole proprietors may want to restructure their businesses for the following reasons:

• They’ve found and appointed new owners or investors.
• They seek business funding, with their prospective lender asking them for a formal business plan before granting a loan.
• They also seek the legal and tax advantages of LLCs, corporations, or similar structures.

Before converting a sole proprietorship into another business structure, it’s important to consider the notable characteristics of your chosen type of entity. They include liability and asset protection, taxation, required fees and documents, investment needs, and business continuity. We recommend consulting legal, tax, and business formation experts to help you analyze these factors and choose the best business structure to convert a sole proprietorship into.

Which Structure Should I Choose: LLC or Sole Proprietorship

LLCs and sole proprietorships have several similarities and differences that should be considered before formation.

What Do LLCs & Sole Proprietorships Have In Common?

• Tax obligations: LLC owners and sole traders must submit specific tax-related documents and pay taxes imposed on profits made from doing business.
  • When sole proprietors file taxes individually, their business income and losses are recorded through Schedule C.
  • Filing requirements for LLCs vary depending on how they are structured.
• Business licenses and permits: LLCs and sole proprietorships may need these documents to operate in their state. This typically applies to businesses such as restaurants and convenience stores.
• DBA registration: Many states allow LLC owners and sole traders to register an assumed business name or DBA.

What are the Differences Between LLCs & Sole Proprietorships?

• Liability and asset protection: If you are a sole proprietor, you can be held liable for any legal or financial issues encountered during business operations. Forming an LLC addresses this problem while shielding personal assets.
• Options for raising capital: Running a sole proprietorship can come with two significant challenges: obtaining loans and persuading investors to fund the venture. Meanwhile, LLCs can raise capital by:
  • Adding members to the company
  • Selling shares of stock
  • Issuing bonds to its members (This is possible if an LLC operates as a C corporation.)
• Legal obligations and formation costs: Since LLCs must comply with federal and state laws, they may need to pay additional and ongoing costs. Sole proprietorships aren’t subject to legal requirements, saving them business fees.

Other Considerations

In addition to the similarities and differences listed above, several other factors must be considered when choosing between an LLC and a sole proprietorship.

For example, both entities work differently and present notable risks. LLCs offer asset protection, making them ideal for high-risk businesses. On the other hand, establishing sole proprietorships is best for low-risk businesses and entrepreneurs wanting to see whether their ideas would succeed.

Growth is also important. Sole proprietorships cannot expand because of ownership limitations and challenges in raising capital, but establishing them is practical for new entrepreneurs. As a sole proprietorship starts succeeding and growing, it can be converted into one of several types of LLCs.

Got a Question? Start Here

01

Can you invest in a sole proprietorship?

Yes, you can invest in a sole proprietorship. Investments can be made by:

• Giving startup funds to the proprietor
• Granting the owner a low-interest loan
• Contributing to a crowdfunding campaign (Platforms such as GoFundMe can help sole proprietors obtain startup funds.)
• Partnering with a sole proprietor, thereby restructuring their venture into a general partnership

02

Are sole proprietorships attractive to investors?

Sole proprietorships aren’t considered attractive to investors.

To reiterate, a sole trader and their venture are viewed as one. Thus, the owner must handle all business debts. Most investors see risks in funding sole proprietorships, justifying their preference for investments in larger businesses.

03

What are the major disadvantages of a sole proprietorship?

The major disadvantages of a sole proprietorship include:

• Unlimited legal liability - The owner is responsible for all business debts and obligations.
• Restricted access to capital
• No operational continuity or succession - Sole proprietorships cease operations once their owners retire, become unable to work, or die.
• Management-related challenges due to inadequate skills and experience

04

Is it profitable to become a sole proprietor?

Yes, it’s profitable to become a sole proprietor.

Instead of sharing profits with partners or shareholders, you receive all of them and use the money for other purposes. For example, some of your earnings can be saved for expansion, recruitment, or other important aspects of your business.

The Bottom Line

Starting and investing in a sole proprietorship offers various advantages. This common type of business has a simple structure with minimal costs, few legal requirements, and full operational control attached to it. However, if legal or financial issues arise, sole proprietors risk losing their assets and credibility.

Professional expertise can help you decide whether to form a sole proprietorship or adopt a more complex business structure. NCH demonstrates over 30 years of experience in business formation, allowing us to understand your specific needs and guide you through this complicated process.

Call us at 1-800-508-1729 to get started today!

DISCLAIMER: The above material has been prepared for informational purposes only, containing opinions of the provider and is not intended to provide, and should not be relied on for, tax, legal, or accounting advice. Please consider consulting tax, legal, and accounting advisors before engaging in any transaction.

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