What Is A Proprietorship? (Advantages And Disadvantages)
Updated 30 September 2022
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A proprietorship, also commonly known as a sole proprietorship, is a type of business that is popular due to its simplicity, easy setup and management. Most small business owners are sole proprietors of their companies. If you are planning a career in management or business development, you can benefit from knowing more about proprietorship firms. In this article, we answer, 'What is a proprietorship?', discuss how to create a sole proprietorship and list the advantages and disadvantages of this business type.
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What Is A Proprietorship?
To answer 'What is a proprietorship?', it is important to understand the concept of a simple, unincorporated business with a single owner. A sole proprietorship is a business that is not separate from its owner. The company's income and losses are taxed on the business owner's personal tax return. It is important to note that a sole proprietorship is not a legal entity but a person who operates and takes full responsibility for the business. Sole proprietorships can operate under the name of the business owner or under a fictitious name.
This type of business is the simplest type of company in existence and is incredibly popular because of the simplicity in which it can be set up and operated. A sole proprietorship only needs a local licence and registered name. Most companies begin as a sole proprietorship and eventually advance to a more sophisticated business type as the company grows.
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Types Of Proprietorships
Proprietors can work as freelancers, independent contractors, business owners or franchisees:
A freelancer is a self-employed sole proprietor who takes on projects on a contract basis as per their availability. They have the freedom to choose their clients and when they want to work with them. Working as a freelancer does not require a lot of capital. In most cases, freelancers have full-time jobs and work freelance on the side.
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Business owners can also work as self-employed proprietors. They have more autonomy in dealing with clients. The business itself may also be more complex and involve other employees and stakeholders.
Franchise owners can also function as sole proprietors. Like business owners, franchisees also have a certain autonomy with management style. In exchange for royalties paid to the franchisor, the franchisee receives guidance, brand and business model.
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How Businesses Create Sole Proprietorships?
Most businesses undertake the following steps to create a sole proprietorship:
1. Identifying the kind of business
As the first step, independent business owners might want to consider whether a sole proprietorship fits their type of business. Several businesses can benefit from being a sole proprietorship, which is why a lot of business owners choose to start their businesses as sole proprietorships. Later, as the company grows, they convert the company into a more complex organisation. Some of the common businesses that begin as sole proprietors include:
Freelance photographers, writers and editors
It is important to determine what type of work a business is going to do to figure out whether a sole proprietorship is a right option for them.
2. Determining whether sole proprietorship works for the business
Once an individual decides on the type of company they want to start, the next step is to decide whether a sole proprietorship works for them. The four most common types of businesses are sole proprietorship, partnership, corporation and Limited Liability Company (LLC). Before deciding which option is suitable, it can be useful to know the pros and cons of each type of business. Sole proprietorship works for small businesses depending on their needs.
3. Analysing the sole proprietorship requirements
There are different requirements for running a sole proprietorship in every country. If the company decides on starting a proprietorship business, the next step is to enquire about what is necessary to start the company in its respective country, city and state. Enquiring about the different registrations and licences beforehand can help to avoid complications later.
4. Picking a name
Businesses can run a sole proprietorship under the owner's name or under a fictitious name (for instance, Raj's Baked Goods). Before picking a name for the company, check whether another organisation has already trademarked it. Registering the same trademark as another company means they can sue the new business for trademark infringement.
5. Registering for a licence
Registering for a sole proprietorship is not mandatory. Businesses who still want to register a sole proprietorship can choose one of the two options: register under the Shop and Establishment Act or get an Aadhaar number. Companies can also get a GST registration if the business turnover exceeds the limit set by their respective state.
6. Creating a domain
In the age of social media, most businesses create a website to sell their products and increase their reach to customers. Besides, a website can draw traffic and promote products and services to a larger audience. To create a website, a company can start with buying a domain. This is fairly easy and includes the following steps:
Finalising the domain name and ensuring nobody else has used it
Choosing a suffix for the domain, such as .com or .net
Paying a fee to the domain registrar for the domain name
Adding a Domain ID protection to protect the website against cyberattacks
7. Opening a bank account
The last step is to set up a separate bank account for the proprietorship. This ensures that cash inflows from the sole proprietorship are separate from other sources of income. Plus, business owners can easily keep a track of their business transactions and avoid mixing them up with personal expenses.
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Advantages Of A Sole Proprietorship
There are several advantages to operating a proprietorship:
Simplified business ownership
It is easier to manage and own sole proprietorships. Some of the problems included in an LLC or corporation involving company officers or registered agents are absent in this type of business. As the sole business owner, you can have full ownership of your finances, decisions and company functions.
Easy to establish
A sole proprietorship is the easiest and simplest type of business. It is especially beneficial for someone who is looking to turn a hobby or side hustle into a full-fledged career or those who do not have sufficient funds to set up another type of business.
Unlike partnerships, proprietorships do not require legal agreements between two or more parties. The process of registering corporations or LLCs is usually costlier and more complicated. The freedom sole proprietors have is hard to find in most other types of business.
Control over revenue
A sole proprietorship is a small set-up where the business owner can avoid worrying about major payouts. Unlike bigger and more complicated businesses, in a sole proprietorship, there is no requirement to pay lenders, investors and other organisations. Besides expenses incurred by the owner, proprietorships do not have financial obligations.
Related: What Is Revenue? Definition, Types, Examples And More
Simpler tax returns
Business taxes can be complicated to handle. Another major advantage of a sole proprietorship is its simplicity with taxes. The demands are less overwhelming, in comparison with other types of businesses. This can make your life a lot easier when filing taxes.
Fewer registration fees
Starting a new business requires some kind of registration fee. Often, this can be costly, especially when the business has made no money yet. Registering as a sole proprietorship may require a nominal fee. It is a major advantage for businesses owners who are on a budget.
Disadvantages Of A Sole Proprietorship
A sole proprietorship also has certain disadvantages:
No liability protection
Since sole proprietors do not have complicated registration processes, they also do not get any of the benefits that come with being a legal business entity. Sole proprietors are self-employed, meaning that they are on their own with business dealings.
While it is an advantage, the sole proprietor's liability for the company's legal, financial or tax problems is a disadvantage. For example, LLCs offer protections preventing people from suing them personally for business-related issues. Such protections do not apply to sole proprietors, which means there can be additional risks if there are problems with the business.
Tough to get financing
Another disadvantage of a sole proprietorship is that since it is one of the less organised types of business, it can be harder to secure loans or business credit. This is because most banks want to work with established companies with a more substantial credit history. Plus, since a single owner provides all the liability and backing, the business is entirely reliant on that individual's initial investments and finances.
Harder to sell the business
A sole proprietorship and its owner are almost inseparable entities. It is difficult to sell or hand down the business to someone else. If a sole proprietor decides that they no longer want to run their business, they can sell the business assets, rather than the company itself.
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