Why form a sole proprietorship?

Forming a sole proprietorship model for a small business is easy. As a sole proprietor, you can still employ people or choose to work entirely on your own, as a freelancer, for example. If you are considering self-employment and want to know why forming a sole proprietorship might be advantageous, then read on.

Let’s get something straight: being a proprietor of a business simply means being its owner. You could own a business without ever doing any work for it, however. For example, you might simply buy a majority stakehold and become a silent partner in an already established business. The important difference between a sole proprietorship business structure and a partnership is that you are the only owner. That means you are the sole owner of the business name, its assets, its debts – if it has any – and any income that might be generated from it.

The appeal to a self-employed person of this kind of business structure is that they also take ownership of 100 per cent of the profits. For many, the whole idea of getting a start-up off the ground is so they can become masters of their own destiny and generate a personal income that directly relates to the profit of the enterprise they own. As the business owner, you are the sole decision maker, you can run things your way and you can try out new ideas without anyone else to say, ‘no’. If you work in a partnership with another self-employed person, then you will always have to compromise to an extent on decision-making, even if you have the majority share.

So far, so good, right? But what else do you need to consider about this type of proprietorship model?

The legal formalities of sole proprietorship

If you want to be a sole proprietor in the UK, then you can do it straight away. You can do it today. Even if you are currently holding down a job which does not have a contractual clause expressly forbidding it – and few do – you can become a sole proprietor immediately. All you need to do is to inform the tax office that you are now self-employed. Do this even if you don’t have any income yet from your business so that your future tax issue does not become complicated. As the owner of a sole proprietorship enterprise, you will need to fill out a self-assessment tax return at the end of the financial year to pay income tax regardless of whether your enterprise went into profit or not.

It really is as simple as that for sole proprietors who want to go about sole trading. As a sole trader, your tax is worked out from your earnings derived from employment plus the taxable profit you made from working for yourself. Many home-based businesses do perfectly well with this model. What’s more, you don’t need to register your business name. You can use your own name or a brand name as a sole trader which means that setting up inexpensively is possible. In the US, you often have to register a fictitious name if it is considered to be ‘doing business as’, or DBA, and pay a fee. In the UK, this is not necessary unless your chosen name infringes a copyright or a trademark in some way. It is only if you want to limit your personal liability against debt as a sole proprietor that you will need to register your chosen business name with Companies House.

What disadvantages are there of sole trading compared to limited liability?

Sole trading is a popular legal entity for a sole proprietorship model because income tax is relatively easy to work out. The tax authorities allow sole traders who have a relatively modest turnover to use the cash accounting method to work out their tax obligations. This means you can work out your business income by adding up your total receipts and taking away any allowed deductibles on your tax return. For this reason alone, many small businesses remain as sole trading ventures without ever changing.

That said, there are some disadvantages to consider, too. Sole trading means being liable for all of the business debts that may accrue. As such, your personal assets – your car and house, for example – could need to be sold to pay creditors in the event that any debts you are liable for get called in. This sort of liability can be limited if your sole proprietorship goes through an incorporation process. This is done at Companies House where all limited liability companies are registered. The incorporation process can be completed online via their website along with a small fee. As the owner of a business with liabilities which are limited in law, your personal possessions are deemed to be separate from that of the business.

Many business owners who want to go on and build a large corporation go about filing their application with Companies House from day one because having ‘Ltd’ at the end of the business’ name simply sounds more professional. That said, freelancers and independent contractors are perfectly entitled to go about the same process and still remain in the sole proprietorship model.

A word of caution should be mentioned, however: once you choose to alter the entity of your business in law to a limited liability one, you will automatically be required to pay corporation tax. Your income tax will still be tied to the enterprise’s profits but you may be able to pay yourself with dividends which could reduce your personal tax debt in a perfectly legal manner. It is worth hiring an accountant to help with self-employment tax if you are the owner of a limited company.

Going it alone

Running a small business can be a little lonely if you are the sole decision maker. Some professional people who sell their service under a business license find that they miss the camaraderie of the office. However, as a sole proprietor, there is nothing to stop you from working alongside others. Sometimes, you will be part of a team if you undertake a multi-disciplinary freelance project within another business organisation, for example. You can also take on paid staff to work for you without ending the sole proprietorship. That said, many sole proprietors will spend days and even months on end working by themselves. If you think that growing a company like this is not for you, then you ought to consider the benefits of going into business with a partner.

With a business partner, you get to share the risks and the rewards of running an enterprise. You also get to bounce ideas around and have someone to rely on if you are ill or go on holiday. Overwhelmingly, however, sole proprietorship suits entrepreneurs because it offers them the chance to generate income and develop their business ideas without the influence of anyone else. If that sounds like it appeals to you, then why not be the sole proprietor of your own enterprise and go it alone?