Sole proprietorship is the easiest and least expensive way to start a business. If you're just getting started in business and wondering why a sole proprietorship might be a shrewd business move, stay tuned.
In today's video I'm going to share with you the top five reasons that you should, or shouldn't, operate as a sole proprietorship.
So if you're just starting out on your business and you can't figure out whether or not you should operate as a sole proprietorship or an LLC or a corporation or something else entirely by the end of today's post, you're going to have a systematic process that you can use to determine whether or not a sole proprietorship is the right business entity for your business, or whether you should be looking at other options. There are five main issues that you need to consider when you're starting a business and trying to pick a business entity, and today we're going to go through those one at a time. So let's dive in.
How Viable is Your Business Idea?
All right. So number one is how viable is your business idea? Now, I know I've talked about this before, but if you're just starting out in business and you don't yet know whether or not the business idea that you have is actually a viable business idea, then a sole proprietorship might be the right decision for you. With a sole proprietorship you have complete control over the operations of the business, how it's set up, where you're going to operate, the types of products you're going to use, all that type of stuff. And you don't need to worry about when you're just getting started out, any type of corporate formality.
In addition, the legal startup costs, they're virtually nothing. All you really need to do to open up a sole proprietorship is open up a checking account, and file a DBA. Third thing that you might need to do is sign up for some licenses wherever your business is located. So if you're just getting started and you don't have any clients and you're not generating any revenue, then a sole proprietorship might actually be a pretty shrewd business move and will actually save you quite a bit of money, at least in the short term. Now I'm not saying that you're going to stay that way. You can always switch and form a corporate entity later, but for now there's no harm in starting as just a sole proprietor.
How Much $$$ Do You Have?
So the second consideration is how much capital do you actually have to invest in your business? If you're operating your business on a shoestring budget, meaning you really don't have any capital, then chances are you probably should start as a sole proprietorship. Let's take an LLC, for example. If you're starting out as an LLC, it can cost anywhere from several hundred dollars to several thousand dollars, depending on whether or not you hire a lawyer to help you. And that's just the setup costs. Again, I'm not saying that you need to stay a sole proprietorship, but after you start generating some revenue, after you get some clients, after maybe you generate some product sales and you have some money in the bank, then is a good time to go back and look at your corporate entity and maybe form an LLC. And maybe you even hire a lawyer to help you.
Could You Get Sued?
Third consideration. Is your business at high risk for getting sued? Let me explain that here for just a second. First of all, if you don't have any clients go back and see number one, if you don't have any clients and you don't have any product sales, there's nobody to sue you. But after you start to get some clients and you are starting to generate some revenue, that's when you really need to sit down and think, “Well, do I really need a sole proprietorship or not?” But after you start to get some clients and you do have some product sales and you are generating some cash, then it's a good idea to sit down and basically have a meeting with yourself and say, “Does it make sense to stay a sole proprietorship? Or do we need to make another choice in terms of our business entity?” Because honestly, some businesses are just at a higher risk of getting sued than other businesses.
With online businesses it really depends on the nature of your business. Whether you're an online coach, an entertainer, a journalist, a blogger, you're building an agency, anything like that, then you really fall into this gray area where it's going to depend on the business that you're in and the types of clients that you're going to be working with. If you are concerned about getting sued, and this is going to really be specific to your business, if you are concerned about getting sued, if you think that's something that could happen to you, then honestly, a sole proprietorship is probably not the best option for you.
And that's because with the sole proprietorship, if something were to happen and you were to get sued or your business were to get sued, you are going to be held personally responsible for the debts and obligations of both the business and the people you employ in the business.
What are Your Goals?
Let's look at the fourth consideration and maybe this is a little bit philosophical for you, maybe not, I'm not sure. What are your business goals? What is it that you want to accomplish from your business in the next five years? Are you going to be seeking outside investors for your business? Do you want to hire lots of staff or employees for your business? Are you looking to build a multi-million dollar empire that's larger than life? If any of those things are what you want, then you're probably going to outgrow a sole proprietorship pretty quickly.
On the other hand, if you're running a small business, maybe you're a freelance writer or an independent contractor that does work for a small number of clients, and you don't really have any legal exposure, and you just want to build up a business that's going to fund your lifestyle, allow you to have some freedom to travel and do things that you want on your time and your schedule, then maybe a sole proprietorship is actually a pretty good decision.
Fifth consideration. Are you concerned about getting audited by the IRS? I know this seems a little far-fetched, but just stick with me here. If you are a cash-based sole proprietorship, you might as well have a big red target on your back that says to the IRS, “Please audit me.” So if that sounds like your current situation, then honestly you might want to consider forming a business entity. And even if you're not a cash-based business, you still might want to consider forming a business entity if getting audited by the IRS is a concern that you have because honestly, and this is just the way it is, if you are a business entity, you are at a lower risk of getting audited than if you are a sole proprietorship.
So now you know the exact systematic process that I use with my clients to help them decide whether or not they should stay in place as a sole proprietorship or whether they should form some other type of business entity.
I've written a one page cheat sheet that goes over all these issues and many more in terms of deciding what type of business entity is right for your business. And if you want to go ahead, here is the link. You can download that. It'll help walk you through the process that I use to decide what is the best business entity for a client that I'm working with.
Also, if you want to join a community of online entrepreneurs just like you, I have a secret Facebook community where I share even more legal tips and tricks to help you keep your online business protected and profitable. Have a good one, folks. Take care.