Forming a Sole Proprietor verus a Corporation or Partnership


A sole proprietorship is the simplest legal business form of the three. A sole proprietorship, as the name implies, is a business structure that has only ONE owner. There is no distinction between the business assets and the owner of the operation. Moreover, if a sole proprietorship (the business) cannot pay its bills, creditors can sue the owner and take claim of his or her personal assets. In other words, the owner has unlimited liability; beyond the extent of his/her personal investment into the sole proprietorship.

A sole proprietorship can be dissolved at any time and is automatically dissolved upon the death of its owner. The owner of a sole proprietorship has complete  control over the operation and direction of the business. As a result, the owner MUST accept all responsibilities and assumes all risks. Furthermore, the owner is personally responsible for all debts incurred by the business and, in many cases, is responsible for any wrongdoings of his/her employees.

The cost to register a business name as a sole proprietorship can range between $100 and $200. In many jurisdictions, however, if the owner uses his/her own name, as their business name, the business does not have to be registered and therefore, no cost is incurred.

The owner of a sole-proprietorship may experience difficulty in selling his/her business, since the businesses' name and reputation are not generally passed on to future owners. In addition, the businesses' ability to obtain financing is limited by the personal credit status of the owner. The scope of management expertise is generally limited by the personal skills and background of the owner. In essence, the organizational structure of a sole proprietorship may impede the future growth and growth potential of the business.

Owners of a sole proprietorships periodically "DRAW" (withdrawal) cash from their company to pay for personal living expenses. These monies are referred to as drawings. Many owners of sole proprietorships consider drawings to be a salary. From a legal stand point, however, a cash drawing is not and should not be considered a salary of the owner. The reason is simple; owners of a sole proprietorship CANNOT enter into a legal binding contract with him or herself and therefore, CANNOT hire & pay him or herself a salary. In order words, if an owner of a sole proprietorship plans to receive money from their company, they will receive it through drawings; not a salary.

Accounting for a drawing and a salary has accounting implication. Furthermore, a salary is considered an expense of the business and therefore, reduces the company's taxable income (thus reducing their tax obligation). A drawing, on the other hand, is NOT an expense and therefore, does NOT reduce a company's taxable income. Moreover, as discussed under the equity section of the Balance Sheet, a drawing reduces an owner's capital (or ownership) in his/her company.

All earnings accrue to the owner and any losses can be written off against his/her other sources of income. Losses incurred by a sole proprietor generally cannot be carried forward or carried back.

In a nutshell, many businesses begin their lives as a sole-proprietorship, only later to become a partnership or an incorporated entity.

Categories: General