How to start a sole proprietorship in 7 steps
With over 23 million registered businesses in the United States, sole proprietorships are by far the most common type of business entity in the country. They’re convenient to form and an affordable option for aspiring entrepreneurs. But before you jump into launching your small business, use this guide to learn exactly how to start a sole proprietorship.
You’ll also learn the advantages and disadvantages of starting a sole proprietorship to determine if it’s the right business entity for you.
What is a sole proprietorship?
A sole proprietorship is the simplest business entity small business owners can form. Sole proprietors have complete control of the business, revenue, and decision making.
Sole proprietorships have low barriers of entry and offer an affordable way to launch your business. Independent contractors, small business owners, and franchise owners all pursue sole proprietorships as their business structure. Whether you’re a landscaper, financial planner, or caterer, a sole proprietorship may be the perfect fit for your company.
Advantages of a sole proprietorship
Sole proprietorships are easy to form and have a simple management structure. They also simplify your taxes since you can pass all earnings to your personal income taxes.
Easy to form
Setting up a sole proprietorship is much easier than starting other business entities. Sole proprietors aren’t required to register with their state, and you don’t need to worry about complicated legal agreements with other business partners.
You can also avoid other time-consuming tasks that other business entities require, like choosing a board of directors or allocating stock to shareholders. Since you’re the sole owner, you can simply start running your business.
However, there are licenses and permits you’ll need to legally operate your business. For example, you may need zoning permits, sales tax permits, or a liquor license based on your type of business. Check with your state or local government to determine which permits and licenses you’ll need to operate your business.
Simple management structure
Sole proprietors have full control of their company and don’t need to worry about complicated business management structures. You are in charge of all business decisions, revenue, and business planning.
Conflicts among business owners are one of the most common reasons why businesses fail. Sole proprietors avoid this risk since they have full control of their business.
Taxes are simplified
When you start a sole proprietorship, your personal assets and business assets are rolled into one category, which simplifies the tax process.
Sole proprietorships have pass-through taxation. This means that all business earnings are reported directly on your personal income tax return. You avoid double taxation, which occurs when you’re taxed on your business earnings and your personal income.
As a sole proprietorship, you can also gain access to certain tax deductions. For example, the Tax Cuts and Jobs Act of 2017 allows a 20% tax deduction from your business income.
Disadvantages of a sole proprietorship
While they have many upsides, sole proprietorships also come with a few downsides. They leave your personal assets vulnerable since you have unlimited liability. They may also make it more challenging to land new clients, partners, and investors.
You’re personally liable for debts and lawsuits
Sole proprietors are personally liable for any incurred business debts and aren’t protected if a third party wants to take legal action against your business. As such, your personal assets—like your home, credit score, or personal savings—are on the line if someone decides to sue you or your business has to file for bankruptcy.
For instance, say you run a lawn care business and one of your employees accidentally damages a client’s property. Your personal assets are at risk of seizure if the client decides to sue your company for damages.
Sole proprietorships can be a risky choice, especially if your company is in an industry where injury or property damage may occur—and while insurance coverage can help protect you (more on that later), it’s not foolproof.
You’re the sole owner
Sole proprietors are in full control of the fate of their business. Sure, you get to make all the decisions and receive all the revenue, but this brings some challenges as well.
For one, you risk overextending yourself. Most sole proprietors are in charge of all facets of the business, including finance, marketing, and operations. This can take a significant mental toll since you’re in charge of making every decision regarding your business. As such, you could end up quickly burning out.
Sole proprietors are also inseparable from the business. This means that if the sole proprietor leaves, so does the business. The succession plan is blurry, especially because sole proprietors are the face of the company and have likely built relationships with clients to establish strong customer loyalty.
Landing new clients and investors could be a challenge
While it may seem trivial, potential clients and investors sometimes see a sole proprietorship as less professional than a limited liability company or corporation. In some cases, these outside parties may not take your business seriously or may be wary about doing business with you.
Sole proprietorships are unincorporated companies, which means you haven’t formed a separate legal business entity. Clients or investors may be cautious of working with an individual rather than a separate legal business entity.
For example, a larger client may only choose to do business with incorporated businesses instead of sole proprietorships based on a perceived sense of stability.
Some banks even require business owners to incorporate before they lend money. This could stall your growth efforts if you ever need outside funding to take your business to the next level.
How to start a sole proprietorship: 7 steps to take
You may have a side hustle that you want to turn into a full-time business, or maybe you just want to launch a new business from the ground up. Either way, you’ll need to know how to start a sole proprietorship. Here are the steps you can take:
1. Choose a business name
To begin, you need to come up with a business name. Brainstorm a few different names that are unique and succinctly describe your business. You can also have your business name be the same as your personal name—we’ll discuss more in the next section.
Once you have some business name ideas, check the United States Patent and Trademark Office (USPTO) to see if they’re available. Once you find an available business name you like, you can move onto registering your business name.
2. Register your business name
Sole proprietors have two options when it comes to a business name. Your business name can be the same as your personal name or you can file your business under a different name.
You’ll need to use a fictitious business name or a “doing business as” name (DBA) if you don’t want to use your personal name for your business.
DBAs aren’t required in most states, however, they come in handy when you open a business banking account or business credit card since these institutions require you to separate your business and personal finances into two different categories.
Each state, county, and municipality has different DBA requirements and registration processes. You can check local government offices and websites for more information about registering your business.
3. Purchase a website domain name
Once you’ve settled on a business name and have registered it with your state, it’s time to purchase your website domain name. Your domain name is what identifies your site. It looks something like this: www.example.com.
It’s best to set your domain name as the same name of your business to avoid any confusion. If the domain name you want isn’t available, come up with a variation that is still similar to your business name. It’s alright if you’re not ready to build your website just yet. You can still reserve your domain to ensure no other business takes it.
Get found for free
Show up for any of the millions of customers on Yelp searching for a business like yours.
4. Obtain a business license and other permits
It’s crucial that you’re doing everything by the book and obtain all the appropriate business licenses and permits. Without the appropriate licenses or permits, you risk incurring hefty fines.
Licenses and permits will depend on the nature of your business and which state and local area you’re operating in. For example, health and safety training is required if you’re opening a daycare. Likewise, a health department permit is required if you want to prepare or serve food.
5. File for an employer identification number (EIN)
In most cases, your Social Security number will serve as your tax ID number. However, you’ll need an employer identification number (EIN) if you decide to hire employees or set up a retirement plan. An EIN is what you provide to the Internal Revenue Service (IRS) when you file your taxes. Obtaining your EIN is a free, easy process that can be done on the Small Business Administration’s website.
6. Open a business bank account
Even though revenue from your business is passed directly to your personal income, it is recommended that you separate business expenses from your personal expenses.
Having a business account allows you to accept credit card payments and written checks, plus it gives you the ability to build a credit history for your business.
A separate business account also lets you clearly show the IRS profits and losses. The first few years of your business may incur losses. A separate business account details expenditures—like office space, business travel, and banking fees—so you can write them off on your taxes.
7. Get insurance coverage
As mentioned, a sole proprietorship means you have unlimited liability if your business goes bankrupt or someone decides to take legal action against you. Additional insurance coverage can limit the risks and give you some protection against these scenarios.
Depending on the nature of your business, you’ll want to look into the following types of insurance:
- Property insurance
- Liability insurance
- Auto insurance
- Health insurance
- Disability insurance
Getting insurance may seem like a large expense. However, you’ll be protecting your personal assets if you ever encounter an unfavorable situation. You can look into different types of insurance coverage on the Small Business Administration website.
Get one step closer to being your own boss
Once you know how to start a sole proprietorship, you’ll discover it’s an affordable and relatively easy way to launch your own business. There are few barriers to entry and it allows you to truly be your own boss. However, it does come with some risks, like being vulnerable to unlimited liability.
Determine if a sole proprietorship is the right fit for your business endeavor. When you’re ready to move forward, check out this ultimate guide to starting a small business.