One of the most common and straightforward ways of starting a business is to establish a sole proprietorship. Although it’s often thrilling, becoming a small business owner also poses real challenges—even for entrepreneurs who use this basic type of business structure. Learn about sole proprietorships and the various types available, and get a step-by-step guide on how to start one.
What is a sole proprietorship?
A sole proprietorship is a business owned by an individual, known as a sole proprietor, who operates the business alone and typically in their own legal name. It is the most straightforward business structure, with complete control in the hands of the owner. For this reason, the business and the owner are considered a single entity, without separation for tax and legal purposes. This is in contrast to other business structures, such as corporations or limited liability companies (LLCs).
When a freelancer strikes out on their own—whether they’re a graphic designer, a business consultant, a writer, etc.—the default designation for income tax is as a sole proprietorship. A sole proprietor also can make and sell products, though usually when a business scales up it chooses to operate as a corporation. This establishes a separation between the finances and legal obligations of the company and its owner or owners.
Types of sole proprietorships
Solo business owners have several options for how to structure a sole proprietorship. Choosing the right one depends largely on the nature of your business:
Unincorporated sole proprietorship
This is the simplest sole proprietorship, where the business operates under the owner’s name. It requires minimal paperwork and is the easiest to set up. The owner is personally liable for all business debts and obligations.
Fictitious business name sole proprietorship
When an owner wants to operate their sole proprietorship under a business name different from their own, they must register a fictitious name. It is sometimes known as a “doing business as,” or DBA, name. This type of sole proprietorship provides a bit of anonymity and allows for branding, but like an unincorporated sole proprietorship, the owner remains personally liable for all business obligations.
Professional sole proprietorship
Accountants, consultants, doctors, lawyers, and other professionals sometimes practice under a professional sole proprietorship. This structure requires compliance with specific licensing and regulatory guidelines related to the profession while retaining the simplicity of a sole proprietorship.
How to start a sole proprietorship
- Start with a business idea
- Assess business structure needs and tax considerations
- Choose a DBA, if needed
- Obtain necessary business licenses and permits
- Open a business bank account
- Obtain a federal employer identification number (EIN)
- Purchase business insurance
- Conduct health and safety training
- Manage your finances
Starting a sole proprietorship requires having a plan, putting it into motion, and complying with relevant laws and tax obligations. The following steps can help:
1. Start with a business idea
Refine your business idea and conduct thorough market research. Understand your target audience and competition, and define your business’s unique value proposition.
2. Assess business structure needs and tax considerations
Determine why a sole proprietorship might be right for your business. Look into tax implications, including personal income tax rates for self-employed workers, which can vary depending on the state or city where you live.
3. Choose a DBA, if needed
If you’re not operating under your own name, select a fictitious name that is memorable and complies with legal requirements in the state where your sole proprietorship is based. Ensure your name is unique and doesn’t infringe on any active trademarks. Register your DBA in your state of incorporation, usually with your local county clerk’s office.
4. Obtain necessary business licenses and permits
Check with your state and local government offices—such as the Secretary of State or office of incorporation—to identify any business licenses or permits you may need. You may need a permit from the local health department, a permit to collect sales tax, even a permit to occupy office or work space. Ensuring regulatory requirements is crucial. This can help prevent headaches down the road, including having your business fined or shut down by regulators.
5. Open a business bank account
It’s helpful to keep your business transactions separate from your personal finances, even when operating a sole proprietorship. Opening a dedicated business bank account simplifies accounting by letting you more readily track business costs. This can help you or your accountant identify which expenses are eligible for deduction from your income taxes.
6. Obtain a federal employer identification number (EIN)
Although not always required for sole proprietors (who are often identified by their Social Security numbers for tax purposes), getting an EIN can have benefits. It may be necessary if you plan to open accounts with certain banks, accept credit card payments, or hire employees. An EIN can also act as an extra layer of security against identity theft.
7. Purchase business insurance
Consider buying business insurance to protect your business and personal assets. Policies can cover general liability, property loss or damage, or provide other protection depending on your industry or equipment needs.
8. Conduct health and safety training
In some cases, you may need to train employees (if you have them), and undergo health and safety training yourself. You also may need to research and adhere to certain industry-specific standards for health and safety.
9. Manage your finances
Keep detailed records of business expenses, income, and receipts. Consider consulting a tax professional to maximize your tax deductions because taxes on self-employed individuals can be high in some states.
Advantages of a sole proprietorship
Running a sole proprietorship comes with several advantages, largely because of the structure’s relative simplicity and ease of setup. This makes it an attractive option for small entrepreneurs running lean operations. Here are a few of the advantages:
As the sole owner, you have total control over all of the sole proprietorship’s business decisions and activities. Without other business partners, who may have ideas that differ from your own, you can implement your personal vision.
Sole proprietors report business income on their personal tax return. This simplicity can save time and reduce accounting costs compared with incorporated businesses, such as C corporations (C corps) or LLCs.
Direct access to business profits
Unlike other business entities, where partners or shareholders can claim a share of the earnings, sole proprietors receive all the profits the business generates.
Disadvantages of a sole proprietorship
The simplicity of the sole proprietorship also has some drawbacks, including:
Perhaps the most significant disadvantage of running a sole proprietorship is the owner is personally liable for all business debts and legal obligations. This means, if the business owes money, faces lawsuits, or encounters financial difficulties, both the business assets and the owner’s personal assets are at risk. This includes the owner’s personal savings, home, and other property.
Unlike more complex business structures that provide legal separation between a business and its owners, the sole proprietor bears full personal responsibility for the business’s success or failure.
Limited financial resources
Sole proprietors may encounter more difficulty raising capital from banks or outside investors compared to larger business structures like corporations. This can hinder the ability to expand or undertake larger projects. The reliance on personal savings or small loans can also strain personal finances, especially during a business’s early stages.
Limited expertise and skill pool
A sole proprietorship is limited to the skills and knowledge of the owner, which may prove inadequate to various business challenges, from accounting to marketing. In larger, more complex business structures or multiple partners or managers can bring different perspectives, experiences, and skills to the table.
How to start a sole proprietorship FAQ
How do I establish myself as a sole proprietor?
If you begin work as a sole proprietor subject to Internal Revenue Service (IRS) tax forms like a Form W-9, you will be designated an unincorporated sole proprietor by default. To establish yourself as any other kind of sole proprietor, you must choose a business name, register it if you use a DBA, obtain necessary licenses and permits, set up a dedicated business banking account, and pay taxes (including the self-employment tax).
How much does it cost to start a sole proprietorship?
The cost of setting up a sole proprietorship varies. It includes expenses such as business registration fees (if applicable), obtaining necessary licenses and permits, potential fees for legal advice, and the cost of opening a business bank account. These fees can range from about $50 to $500, depending on your business location and specific compliance requirements.
What qualifies you as a sole proprietor?
To qualify as a sole proprietor, you must be the single owner and operator of a business, personally managing its day-to-day affairs and assuming all responsibility for its financial and legal obligations. There’s no formal registration for an unincorporated sole proprietorship, making it a straightforward choice for individual entrepreneurs who want to run their own business.