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Beware Pitfalls: Top Reasons to Avoid Sole Proprietorship

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Last Updated on May 12, 2023 by Kanakkupillai

Sole Proprietorship: Is It Really Worth the Risk? Here’s What I Wish I Knew Before I Started

A sole proprietorship is an unregistered, unorganized business that is managed by just one person and does not distinguish between the owner and the company. A sole proprietorship’s owner is accountable for the obligations, losses, and responsibilities of the company as well as all earnings.

And through this article, we will take you through the meaning, and a total overview of the sole proprietorship such that you can take an informed decision about starting your own entity as the sole owner and decision maker.

What is Sole Proprietorship?

The easiest business structure under which one can run a firm is the sole proprietorship. The one-person business is not a recognized corporate organization. It merely designates an individual who is the company’s owner and is liable for all of its obligations. A single proprietorship may carry on business either under the owner’s identity or a small unbranded name, such as Nicky’s Pizza Shop. The unbranded or raw name is just a trade name; it doesn’t establish a distinct legal entity from the single proprietor owner.

The simplicity of the establishment and low cost of the sole proprietorship make it a well-liked company structure. A single owner only needs to register their name and obtain any necessary local permits in order to start their company. However, a significant drawback of a single proprietorship is that the owner is still individually responsible for all of the company’s debts. Therefore, if a single proprietorship experiences financial difficulties, the company owner may be sued by creditors. If such lawsuits are effective, the owner will be required to use personal funds to settle the company’s debts.

Due to the fact that a sole proprietorship lacks a legally distinct personality, the owner of the business usually signs contracts in his or her own name. Even if the company uses a fake name, the single operator will usually ask clients to make checks in his or her name. Partnerships, LLCs, and companies are prohibited from mixing personal and company assets, but sole proprietors are permitted to do so and frequently do. Bank accounts for sole proprietorships are frequently opened in the owner’s name. The formalities connected with the more complicated company documents, such as voting and meetings, are not required of sole proprietors. Lawsuits against single proprietorships can be filed in the owner’s name (and vice versa). Many companies start out as sole proprietorships and evolve into more complicated company structures as they grow.

Characteristics of a Sole Proprietorship

The following are the major characteristics of a sole proprietorship:

  • Legal requirements:

A single proprietorship can be started or ended without following any official procedures. However, to operate the company for a particular profession, the owner needs a unique authorization or certificate. For instance, a single proprietor starting a drugstore needs a degree in pharmacy.

  • Unrestricted / Unlimited Liability:

The single owner is responsible for the accomplishment or failure of their business dealings. The company owner’s property may be attached by creditors to recoup debts in the event that the owner takes out a loan but fails to return it.

  • Risk and benefit:

The earnings or losses from the business activities belong entirely to the single proprietor.

  • Control:

A single proprietorship’s owner is exclusively responsible for its obligations. A sole proprietor’s company operations cannot be interfered with by anyone else without their consent.

  • Separate Entities:

With the exception of single proprietorships, most business organizations treat the owner and their company as distinct legal persons. Due to the fact that the proprietor manages the day-to-day operations of the company, the organization would not exist without him or her.

  • The going concern concept i.e., Continuity of operations

A company’s survival is connected to its proprietor. Events involving the single owner, such as:

  • death,
  • bankruptcy,
  • fatal sickness, etc.,

may have a negative impact on the company or necessitate its irreversible closure. If the single owner has a formal successor or beneficiary, they can continue to operate the business in their absence.

Pros and Cons of a Sole Proprietorship

Running a single business has many advantages and some drawbacks. Below, we’ll go over a few of those points:

Pros

  • Quick choices

A sole proprietor is entirely responsible for all company choices. The company can make decisions more quickly as a result of not having to consult with numerous parties on every small problem.

  • Maintaining privacy

As the only person making decisions for the company, a single proprietor can keep all business-related details to themselves. They are not required by legislation to disclose the single proprietorship’s financial information.

  • Profit-sharing

Any profits made from company activities are entirely owned by a single proprietor. They are not required to distribute earnings to third parties.

  • Feeling of accomplishment

Since a sole proprietor bears all business-related risks and benefits, even modest success can be more satisfying and cause greater confidence than in other company structures giving a feeling of accomplishment to the person.

Cons:

  • Insufficient resources

Compared to a partnership or company, a sole proprietorship finds it more difficult to collect significant sums of money. This type of company is primarily supported by the owner’s personal assets and borrowings. Inadequate funding may become a barrier to the company’s expansion.

  • Depending on the proprietor

In a single proprietorship, the owner and their firm are one and the same thing. While this has a number of benefits, the survival of this type of company is entirely dependent upon the owner’s health. If there is no successor or heir to carry on the business in the event of death/bankruptcy, etc., the company may close down.

  • Unrestricted/unlimited Liability

The personal property of the owner is also at risk if obligations incurred by the company cannot be repaid with its assets. As a result, single proprietors take no or very little risk to guarantee the longevity of their company.

  • Management of entity

The majority, if not all, of the owner’s responsibilities for the company, include:

  • purchase,
  • customer relations,
  • sales,
  • marketing,
  • bookkeeping, etc.

Although they may hire others to assist in running the company, a lack of funds may prevent the proprietor from hiring full-time employees and paying them appealing salaries. As a result, the owner might have to handle all tasks on their own with little help from others.

The Pitfalls of Sole Proprietorship

The Pitfalls of Sole Proprietorship by Kanakkupillai

  • Personal liability for business debts

The limitless liability that sole proprietorship and partnership businesses force on their participants is one of the most disconcerting features of these types of businesses. In this case, unlimited liability means that the business proprietors may be held liable for any obligations that the company is unable to pay.

  • Lack of legal protection

The sole proprietorship does not exist as a separate legal entity like a company of LLP. Due to this reason only, they carry the identity of the owner who is the sole investor in the entity. Hence, the legal protection which is available to the investors and shareholders of a company or LLP is not available to the owner of a sole proprietor. This can result in the loss of all or her personal assets and holdings for any failure in the sole proprietorship entity.

  • Difficulty obtaining financing and No separation of personal and business assets

company financier considers single proprietorships to be high risk due to the owner’s limitless liability and the fact that company assets are not shielded from personal creditor claims. Owners frequently have to use personal resources to finance their businesses, including selling assets, taking out credit card loans, and second mortgages on their houses. An inability to obtain extra financing may also have an impact on expansion plans.

  • Limited growth potential

Ownership businesses i.e., sole proprietorships cannot develop and spread to a large scale due to capital and management constraints. The limitation in management expertise also results in this. For example, for starting a pharmacy you should have a certificate in the course for pharmacy. However, this would not help you ensure that you have enough management skills for running a business which can lead to your failure as an entrepreneur.

Case Studies: Real-Life Examples of Sole Proprietorship Pitfalls

There are tons of sole proprietorship businesses which failed in our country. Some are technical but some you can even see are very basic businesses like running a local grocery store. But in all these situations i.e., technical or non-technical, it is vital that they also have the ability or skill to manage a business which is a higher-level requirement. Bringing up a team together and coordinating them to success is not an easy step.

Let’s take the pharmacy itself as an example.

Mr. A is a having bachelor’s in pharmacy and worked both in India and abroad for more than 10 years as a pharmacist. He worked with some elite pharmacy groups giving him an understanding that the pharmaceutical business is high in value and the business opportunity is immense. With just a pharmacy outlet he can put in the products of multiple giant pharmaceutical companies and make a lot of profit along with creating good employment opportunities.

So he resigned, put together all the savings, and started a pharmacy in India based on his personal analysis which he believed was enough for starting a business.

However, the business did not do well and he had to close down in a span of 3 years making a loss and a debt.

Analysis of what went wrong

What went wrong here is a simple question with a simple answer. Starting from the location to set up a business, Mr. A failed as an entrepreneur. For any business, the brand and the location are important and crucial stuff. Before Mr. A started the business or rented out space for the pharmacy, he should have conducted a feasibility study for such a business in such a location including all the competitors in and around.

But he failed to conduct the study and thereby showed his failure as a businessman at the first step. This would then lead to the brands procuring to even the price to charge and the resources to equip.

And it is important to understand the cost and the revenue that the entity can generate by projecting it, which is the work of the finance team. Mr. A could have understood not a pharmacy and the scope and opportunities of such a business but also how to run a business which is not an easy thing to crack.

Lessons learned

Planning with understanding is the key to any business. Mere possession of the technical knowledge and the certificates will not lead you anywhere. We can sell anything if we know how to do it, added we are in the right place with the right thing and the right time.

And for this, you should have a fully equipped team that requires more funding, and therefore a sole proprietorship which is a one-man show will not help you reach your dreams.

Alternatives to Sole Proprietorship

There are multiple other types of business forms that can be formed to help you stay away from the pitfalls of a sole proprietorship and these include:

  • LLC

In the United States, a limited liability company (LLC) is a type of private firm that incorporates elements of partnerships and corporations.

However, in India, we have the LLP or Limited Liability Partnership which is similar to an LLC.

  • Corporation 

Corporate refers to a group of big companies or a specific large organization. For business customers as opposed to private clients, interest rates are greater. Both the economy and business earnings are expanding. Corporate refers to a group of big companies or a specific large organization.

  • Partnership

A partnership is a type of business where two or more individuals jointly own the firm and are responsible for managing it and for any profits or losses it makes.

How to Choose the Right Business Structure for Your Needs

There are many factors to take into account when starting your own company. Your choice of an organizational framework for your company will be one of your most crucial early choices.

Numerous factors will influence you depending on the company format you choose. It will affect your capacity to collect money from various sources, how much tax you pay, and the risk or liability associated with your personal assets (like your home or savings). This makes picking the appropriate structure when starting your company, a top concern.

  • Legal and tax implications

Each type has a specific tax system. Some organizations are directly assessed because they are distinct legal bodies. such as LLP and Company. For tax purposes, a partnership company is also a distinct entity. Except for minor businesses, all of these documents are subject to a 30% basic tax.

  • Long-term goals

The future of your business. How do you see your business grow and reach a place where it should exist even if you are not aligned with the business? Say, it should have a separate legal existence and a future that can be with or without you. Say, for a sole proprietorship, the existence is limited to the length of your existence. However, for an LLP or company, there is a separate legal existence making it immortal.

Conclusion

A sole proprietorship registration is good but only if you are in the fraternity for a limited period of time and are not targeting greater growth potential.

And if you are looking for a humble start and then to strive into the bigger world then yes, a sole proprietorship may be considered as your business structure for the kick start. However, ensure that you plan, organize and land it well such that it is able to put up until it grows big.

As discussed in this article it is important to know what you have and what you don’t have because help should be taken where you do need help. For example, if we become ill, we don’t really try and treat ourselves but go to an expert doctor and take a prescription. Similarly, the business might also be having areas in which you are not an expert so plan and land it accordingly.

And if you are looking for any assistance then don’t worry because we are here!!

Contact Kanakkupillai Now and grab the opportunity for a free consultation. Don’t Miss it!!

FAQs on Sole Proprietorship

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Kanakkupillai

Kanakkupillai is your reliable partner for every step of your business journey in India. We offer reasonable and expert assistance to ensure legal compliance, covering business registration, tax compliance, accounting and bookkeeping, and intellectual property protection. Let us help you navigate the complex legal and regulatory requirements so you can focus on growing your business. Contact us today to learn more.