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Definition of Sole Proprietorship in Business Insurance

Commercial insurance terms and definitions. Learn more about business insurance terminology and get the right coverage for your business.

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Sole Proprietorship

Entrepreneurship is the backbone of economies across the globe. Small businesses can end up growing into large corporations with a board of directors and stockholders. Before all of that, however, many of these start with a single person. In other words, they’re the sole proprietor.

How Does Sole Proprietorship Work?

A sole proprietorship is the most basic way to start a business. As mentioned above, it is owned by a single person. Others can work for that individual, but they don’t have a piece of the organization.

Under this form of ownership, the person who created the business is entitled to all profits made through sales. Conversely, they’re also responsible for paying off debts and handling potential liabilities.

Formation of a Sole Proprietorship

There are no legalities required to form a sole proprietorship. The owner doesn’t have to file any documents with their state government. Some people may not know they are designated with this title. For instance, freelance writers or virtual assistants are considered sole proprietors.

Nevertheless, single ownership of a business doesn’t stop an individual from obtaining an Employer Identification Number (EIN). This is a unique numerical code that can be used instead of a social security number to designate business revenue and losses on taxes and other government forms.

Despite the status, individual owners still need to request licenses and certifications from the state or federal governments. These will depend on their professions and needs.

Sole Proprietorship vs. LLC

Some business owners interchange their roles as sole proprietors with that of a Limited Liability Company (LLC). There are indeed similarities. For instance, both can be owned by an individual. Yet, they are separate entities.

Under a sole proprietorship, the owner is responsible for the business’ debts and liabilities. If someone attempts to sue the company for negligence or misrepresentation, it’s up to the owner to find legal counsel and pay any corresponding costs.

When an entrepreneur establishes an LLC, they create a shield that protects them from liabilities. However, for this to happen, they must register their organization with the state. Furthermore, they need to maintain their status annually. If not, they are suspended from protections and face the same issues as a sole proprietor.

Advantages and Disadvantages

One advantage of a sole proprietorship is a low-cost or no-cost startup for your business since you don’t have to pay for any certifications. Another is simplified tax filing. You don’t need to separate the revenue and losses from your normal taxes.

On the other hand, a sole proprietorship makes it harder to raise funds for essential expenses. Since they don’t offer any stock incentives, investors don’t have the same impetus to help out.

Another disadvantage is liability ownership. Should someone sue the sole proprietorship for a huge sum, the owner may lose everything to the point that they need to liquidate the business to pay all the costs.

The biggest con of sole proprietorship is the burden the owner takes to make the company work. Though they might have people working under them, they are the ones responsible for the majority of sales and product development. When bogged down by administrative duties, the owner’s priorities can quickly shift.

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