Some people call themselves freelancers. Others call themselves contractors. Under the law, they’re all probably sole proprietors. And in this gig economy, starting a sole proprietorship is on the rise. So how do you start a sole proprietorship?
And once you set up a sole proprietorship, do you have to run it in any special way? How do you pay taxes? Can you have employees? How do you sign documents, as the owner of a sole proprietorship? What are the biggest pros and cons of running a business as a sole proprietor?
We answer these questions and give some tips below.
- What is a Sole Proprietorship?
- How Do I Start a Sole Proprietorship?
- What is the Cost of Starting A Sole Proprietorship?
- The Pros of a Sole Proprietorship
- The Cons of a Sole Proprietorship
- The Sole Proprietorship Is a Good Way to Start a Business, but It’s Better to Grow into Another Format in the Future
What is a Sole Proprietorship?
A sole proprietorship is a person running a business as themselves. For example, if you tie-dyed some T-shirts and sold them to friends and family, then you’ve just started a sole proprietorship.
Sole proprietors often do business under their own names, but they can also use a business name (called an assumed name or trade name). In each case, the sole proprietor calls themselves the owner of the business.
A sole proprietor, as the term suggests, is the only owner of the business. If a sole proprietor needs money to set up or expand their business, they’ll have to fund the activity from their own pocket or borrow money in their own name.
If a sole proprietor wants to take someone else on as a co-owner, then they’ll have to change the business format to a partnership, an LLC, or a corporation.
How Do I Start a Sole Proprietorship?
There’s nothing magical about starting a sole proprietorship. Just start selling goods like cookies or provide services like dog sit. You can do it under your own name, and you don’t have to do it full time. Very often, starting a part-time or hobby business means you’re starting a sole proprietorship.
File an Assumed Name Certificate if You Want to Use a Business Name
If you want to operate under a business name, you’ll need to file an assumed name certificate. For instance, in Texas, you file the certificate in the county you plan to do business in. If you plan to do business in multiple counties, you’d have to file an assumed name certificate in each of those counties.
Here’s our article on how to find a great name for your new business.
The assumed name certificate is usually a simple form that you can find online. Fill it out and go to the county clerk’s office to file the certificate and pay the filing fee (typically less than $100). They stamp it, give you a copy, and then you’re done.
Just search “assumed name certificate” plus your state to find the specific rules for your state. Usually, your state’s Secretary of State’s Office will have instructions on what to do.
Open a Business Bank Account for Your Sole Proprietorship
Once you have your assumed name certificate, you can open a bank account under your business’s name. This way, your customers can pay you as your business. This helps you look like a “real” business.
Even if you just do business under your own name, it’s still a good idea to open a bank account used only for your business. This can be a business bank account or just a second personal checking account. It’s just good practice to separate your business funds from your personal funds. However, as a sole proprietor, there’s technically no legal or tax reason to do so.
To open an account, find a bank of your choice, and tell them you wish to open a business account as a sole proprietor. The bank will help you through the rest. For a more detailed explanation, we have an article on How to Open a Business Bank Account.
How to Sign Documents as a Sole Proprietor
When you sign formal documents such as a contract, you’ll sign like this:
[Signature]
You can use Proprietor instead of Owner, but don’t use Partner, Member, or CEO/President. These are titles usually reserved for other business formats, so you don’t want to confuse people.
What is the Cost of Starting A Sole Proprietorship?
Legally, starting a sole proprietorship costs nothing. If you wish to operate under a trade name, your cost is the cost of the filing fee of the assumed name certificate.
You might have other costs in starting your business, but those costs depend on the type of business you’re setting up. If you have a service business like marketing consulting, you might not have to spend another cent.
If you sell goods, of course, your cost will include all the materials, labor, and maybe physical space to make or sell the goods. You might also have to pay licenses and fees such as a liquor license. It all depends on the type of business you’re setting up.
If you want a simple website and business email, you can do it for as little as $12/year.
Don’t forget that you might have to collect sales tax or pay use taxes. Again, these aren’t really costs of setting up a sole proprietorship. They depend on the nature of goods/services you’re going to sell.
The Pros of a Sole Proprietorship
The primary advantage of a sole proprietorship is that it’s easy to run. Other than keeping track of your income and expenses to know if you’re making or losing money, there are not a lot of record-keeping requirements for a sole proprietorship.
It’s easy to file income taxes as a sole proprietor. You don’t have to file a separate return for your business. You just tally up your business’s profit or loss at the end of the year and file it with your personal income tax return.
For the first year of your business, because business is usually uneven and you might be losing money, you can typically pay taxes on your profits at the end of the year. If your business is just a side gig, increasing your W-2 withholdings for your main job can work, at least for a while.
Once you start to make regular money, even if you’re just in your first year, you’ll need to pay estimated quarterly taxes.
Calculating estimated taxes can get complicated. Fortunately, software like QuickBooks Self-Employed or similar help a lot and don’t cost too much to get. These software are especially useful if your income is uneven. They can help you not over or under pay.
The Cons of a Sole Proprietorship
The biggest disadvantage of a sole proprietorship is that you’re personally responsible for all business liability. This means that if you borrow money for your business, you’re personally liable; if you break something of your customer’s while on the job, you’re personally liable; if you make a widget that ends up putting your customers in the hospital, you’re personally liable. Everything you own would be on the line.
Of course, you can limit your liability by buying business insurance. However, if the insurance refuses to pay or paid up to the limit, you’re on the hook for the rest.
As a sole proprietor, you can hire employees, but this involves additional liability for anything the employee does as a part of his/her job. This is why sole proprietorships tend to be single-person businesses.
Lastly, if you need investors, you can only borrow money from them instead of bringing them aboard as a part of your business. For investors in the traditional sense where they take a stake in your business, you’ll have to go with a partnership, an LLC, or a corporation.
The Sole Proprietorship Is a Good Way to Start a Business, but It’s Better to Grow into Another Format in the Future
The sole proprietorship is an easy, fast, and cheap way to start a business. Eventually, though, people tend to grow out of this business format. The biggest reason to make a change is to limit your business liability.
By the time you reach the point where you have to worry about personal liability, hopefully you’ll have made enough profits to use some of that to pay for the business entity upgrade. This way, you expand your business without having to go back to your personal savings.
DISCLAIMER: This article does not constitute legal advice. Instead, it contains general information. The information gives you the background you’ll need to hit the ground running when you do go get advice from a lawyer. Only lawyers properly licensed in your state/country are qualified to give you legal advice.
Questions? Comments?
