Sole Proprietorships AVE YOU EVER wanted to own and Hoperate your own business? Perhaps you already do. Several forms of business organizations exist, and the simplest is a sole proprietorship. As with any type of business, a sole proprietorship has specific characteristics, advantages, and disadvantages. Objective: þ Identify the characteristics, advantages, and disadvantages of a sole proprietor- ship. Key Terms: Ñ business entity sole proprietorship unlimited liability The Characteristics, Advantages, and Disadvantages of a Sole Proprietorship A sole proprietorship is a business entity with a single owner/operator. A business entity is a professional organization offering something that has real existence. If you sell any- thing or have sold anything, you own or have owned a sole proprietorship. CHARACTERISTICS OF A SOLE PROPRIETORSHIP A sole proprietorship is the oldest, most common, and simplest form of business organiza- tion. This type of business is easy to set up and maintain. No registration with the state is required, as it is with a corporation or a limited liability company (LLC). E-unit: Sole Proprietorships Page 1 u www.MyCAERT.com Copyright © by CAERT, Inc. — Reproduction by subscription only. E060003 A sole proprietorship is rela- tively simple to manage and con- trol. When you own and operate a sole proprietorship, you have the right to be the decision-maker for the business. You are also person- ally responsible for assets, income taxes, and business debts. You can probably think of many businesses that are sole pro- prietorships. If the name of a business contains the owner’s name, the business is likely a sole proprietorship. An example is FIGURE 1. Many farmers are responsible for their own business debts and assets. Fred’s Landscaping. Also, if the business is operated by a single person, it is often a sole proprietorship. Agriculture has many examples of this form of busi- ness organization. For instance, most farmers are sole proprietors. TABLE 1. Characteristics of a Sole Proprietorship • Oldest, most common, and simplest form of • Easily set up and maintained business organization • Owner personally responsible for all assets • One person as decision-maker and liabilities • No registration with the state • Simple to manage and control ADVANTAGES OF A SOLE PROPRIETORSHIP Becoming a sole proprietor to sell something or to offer a service has many obvious bene- fits. Besides farms that sell their crops, businesses that provide simple services (e.g., lawn mowing or snow removal) are often sole proprietorships. What might be some advantages to working for yourself? TABLE 2. Advantages of a Sole Proprietorship • The owner is the boss. • Start-up costs may be minimal. • There are no legal formalities in forming or • It is a good type of organization for a business dissolving the business. that will remain small, has limited exposure to • The money made belongs to the owner. liability, and does not justify the expenses of • Decisions can be made quickly. incorporating and ongoing corporate formalities. E-unit: Sole Proprietorships Page 2 u www.MyCAERT.com Copyright © by CAERT, Inc. — Reproduction by subscription only. E060003 Owning and operating your own business does not mean you cannot have employees. Sole proprietorship means you are the owner and the manager. The business will have a direct effect on your personal bank account. If the business profits a great deal, you will profit a great deal. In contrast, if the business has trouble paying its employees or bills, you will be the last one to receive any money. DISADVANTAGES OF A SOLE PROPRIETORSHIP For each advantage in a sole proprietorship, there is a disadvantage. While the sole propri- etorship is the most popular form of business in the United States, it is also the type of busi- ness that fails most often. When you are the owner/operator, the business is dependent upon you. If you leave on vacation for two weeks, you may have several matters to consider. For example, if you pay your employees each week, who is going to write their checks in your absence? Who is going to make management decisions, such as ordering new material or allowing employees to take days off? If you work by yourself and get hurt, what income will you have? As a sole proprietor, you may find it difficult to raise capital or to get a loan from a bank to start the business. When you do receive a loan, you will usually pay higher interest rates than other types of businesses. When you become the owner, you assume unlimited liability,so you may lose personal assets along with business assets to pay debts owed to others if the busi- ness is unsuccessful. In addition, the business will end when the owner dies. You will have to find your own health insurance and perhaps employees’ health insurance if you choose to pro- vide this for them. You will also be responsible for withholding and paying taxes for yourself and figuring the tax rate for employees. TABLE 3. Disadvantages of a Sole Proprietorship • It is difficult to raise capital to start the • The owner is responsible for personal health business. insurance. • The owner has unlimited liability. • The owner is responsible for withholding and • The business ends if the owner dies. paying all income taxes. • The owner is responsible for the entire • The owner must pay self-employment tax. business. • The owner may have to register the business name and pay local taxes. EXAMPLES OF SOLE PROPRIETORSHIP SITUATIONS Some examples of sole proprietorships and the situations they may encounter follow. Example One Duane is the owner of a small apiary supply business. When business prospects look good, he orders $50,000 worth of wood, which he uses in creating merchandise. Unfortunately, a E-unit: Sole Proprietorships Page 3 u www.MyCAERT.com Copyright © by CAERT, Inc. — Reproduction by subscription only. E060003 FURTHER EXPLORATION… ONLINE CONNECTION: Sole Proprietorship Many people spend more time at work than they do at home. As a result, they should enjoy their jobs. Some people ensure that the boss is pleasant and that the environment is agreeable by working for them- selves. A sole proprietorship is relatively simple to manage and control, and it does not require registration with the state. Although this type of business has numerous benefits, some disadvantages exist. As a result, you should investigate business types before making a decision. To find out more about sole proprietorships, visit the link below: http://sbinformation.about.com/od/ownership1/a/soleproprietor.htm sudden drop in demand occurs, and Duane cannot sell the items he has produced. Several months go by, and the company that sold Duane the supplies is demanding payment. Because Duane has not sold many of his finished products, he cannot pay the company. As a sole pro- prietor, Duane is personally liable for this business obligation. As a result, the business to which Duane owes money can sue him, going after Duane’s business assets and his personal property (e.g., his house, car, and personal bank account). Example Two Megan is the owner of a flower shop. One day Megan sends Marty, one of her employees, out in the company-owned van to deliver some flowers. On the way, Marty runs into a car and seriously injures the other driver. The injured driver sues Marty, claiming that Marty drove over the yellow line and caused the accident. The driver also names Megan in the lawsuit as the co–defendant. After a trial, the jury returns a large verdict against Marty and against Megan as well because she is the business owner. Megan is liable because Marty was working for her business and driving her company vehicle when he struck the other driver. Therefore, the injured driver can go after all of Megan’s assets—business and personal. Example Three Matt owns three acres and uses those acres to plant a garden. He chooses to plant all the acres in strawberries. The strawberries receive the perfect amount of moisture and sunshine, and Matt has a bumper crop. As a matter of fact, Matt has so many strawberries that he employs Charlie, Nathan, and Chris to help pick them and to run a stand to sell the fruit. Matt is able to pay all his bills, including his employees’ wages, and he still receives a profit of $32,000. Matt can use this money to buy seed for his next crop or to make other farm invest- ments; he can choose to pocket all $32,000; or he can do a combination of both. Whatever he decides, all of the profit belongs to Matt. E-unit: Sole Proprietorships Page 4 u www.MyCAERT.com Copyright © by CAERT, Inc. — Reproduction by subscription only. E060003 Summary: 2 Owning your own business is easy. You may have realized you have been a sole proprietor already. You may also have decided that you would like to become a sole proprietor or that you would not because too much risk is involved in this type of business structure. Being informed and making informed decisions is important when it comes to personal liability. However, sole proprietorship is the most com- mon business type in the United States. Many operators never have any trouble with operations and liability issues. As long as your business is not dangerous or too risky, you will find yourself becoming successful when making the correct decisions. Being able to compare the advantages and disadvantages of operating any business is important. Being able to evaluate situations and to make decisions that protect you, as the sole proprietor, is invaluable. Checking Your Knowledge: ´ 1. What does sole proprietor mean? 2. What are three advantages of a sole proprietorship? 3.