A sole proprietorship, in simple words, is a one-man business. This means, it is owned and run by an individual. A sole proprietorship is not a legal entity but a description of the type of business.
Ever wondered what is the oldest form of business organisation? Or what did the ancient business model looked like? Well, it was sole proprietorship. A sole proprietorship is one of the most common types of business entities found in India.
All the businesses that you see around: your local grocer, the chemist, the doctors could all probably be sole proprietors. Let us dive deep and understand different aspects of a sole proprietorship.
What is a sole proprietorship?
A sole proprietorship, in simple words, is a one-man business. This means, it is owned and run by an individual. A sole proprietorship is not a legal entity but a description of the type of business. There are no formal papers required to get started with this type of business.
In case of a sole proprietorship, the individual and the business are one and the same. Although you don’t have to go through official paperwork to establish a sole proprietorship, depending on your state, country or city, you may have to get a business license or a permit. Whether you are required to obtain a license or a permit usually depends on the type of business you run.
What makes this unique?
Wondering what makes a sole proprietorship one of the most chosen business types? Here’s why:
- It’s easy to form, with minimal or absolutely zero documentation requirement
- To run a sole proprietorship is a hassle-free experience. There are no restrictions by a board of directors or miscellaneous tasks like minutes of the meeting or annual meetings
- The owner is in complete control of the business, without having to report or answer to anyone
- The owner is responsible for all the profits (or loss) incurred
Advantages of a sole proprietorship
- In case of a sole proprietorship, the owner will have complete control of the business. This enables an individual to take quick decisions along with the freedom to run the business as per his or her desire
- Indian laws do not demand a sole proprietorship to publish and show its financial accounts or other such documents to any member of the public. This allows an individual or a business to maintain confidentiality, which is sometimes important in the business world
- The owner, in this scenario, makes the maximum incentive from the business. He or she does not have to share any of the profits and hence, the effort he or she invests into the business gets completely reciprocated
- Also, who doesn’t like being their own boss? Being a sole proprietor fetches in a great sense of satisfaction and achievement. You are not answerable to anyone and this in itself is a great boost to your self-worth
Disadvantages of a sole proprietorship
- One of the major limitations that a sole proprietorship faces is the liability of the owner. By any chance, if the business fails, it can wipe out the personal wealth of the owner, also affecting his or her future business prospects
- Another hurdle is the limited access to funding. He or she has to use their own personal savings or they can choose to borrow money (which at times, might not be enough). Banks and financial institutions are also wary of lending cash to sole proprietors
- A sole proprietor has a limited managerial capacity. An individual cannot be an expert in all fields of business. Limited resources might mean that he or she cannot afford to hire competent people for assistance. This can lead to the business suffering from mismanagement and poor decisions
How to set up a sole proprietorship for yourself
Starting a sole proprietorship is simple. All you need is:
- A business name
- A valid bank account
- A running website
As mentioned earlier in this article, you don’t need to register your business with your state but you might need to take care of some legal matters. You will be required to:
- Get a business license from within your locality
- Apply for sales tax permits
- Get specific licenses and permits (depending on your business type)
Taxation policies for a sole proprietor
As a sole proprietor, an individual is supposed to pay income tax by completing Schedule C of the Income Tax Act.
Schedule C lists all the income of your business and then all of the business expenses you would want to deduct. You can also include home business expenses if you work from your home and car expenses if you drive for business purposes.
Furthermore, the total net income from Schedule C is then entered into Line 12 of Form 1040, along with all your other income sources.
You’ll calculate self-employment tax based on the net income of your business and add this after income tax is calculated. The income tax and self-employment tax are totalled to arrive at your total tax liability.
To wrap this up, we can say that sole proprietorships are simple and easy to create, but as your business grows, you might want to decide that establishing a limited liability corporation (LLP) or private limited corporations (PVT) could provide more legal protection against lawsuits, in case your business ever runs into unseen trouble.