If you are about to launch your own business, you have to consider several formats, such as a corporation, a partnership, a limited liability corporation or a sole proprietorship.
For various reasons, you may settle on becoming a sole proprietor, but you should also be aware that there are certain drawbacks.
A look at the benefits
Perhaps you have decided on establishing a sole proprietorship because it is considerably less expensive than forming a corporation or an LLC. Nor do you want to take on a partner. Also, with a sole proprietorship, there is minimum legal work involved. You may need a business license and possibly a permit of some kind if the local government requires you to have one, but otherwise, you can just go ahead and start operations.
Risking personal assets
One of the major drawbacks of a sole proprietorship is that you expose yourself to unlimited liability; there is no corporate structure to protect you. Your personal finances and business finances are one and the same. If someone were to take legal action against your business, you could lose everything: your home, your car, your savings. Courts will use your personal assets to settle a debt or lawsuit.
You may find that you need to raise money as your business grows, but you have no stock to sell, and banks are wary about lending to sole proprietors because they would have to consider your personal assets rather than the financial statements for your business. You may have to use your own savings or obtain a family loan if you need capital.
You will pay less in taxes with a sole proprietorship than if you decided to form a corporation. However, certain benefits, such as your health insurance plan, will not be entirely deductible. You will show any profit or loss for the business on your personal tax return. One interesting point is that your spouse can work for the business without employee status, thereby avoiding the payment of payroll taxes. To be sure, there exist pros and cons of becoming a sole proprietor, and you may want guidance from legal and accounting professionals before you make a final decision.