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Sole Proprietorship And Its Many Disadvantages

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Considered as one of the easiest types of business, incorporation and capital wise, sole proprietorship has been a popular choice among many first time entrepreneurs due to its simplicity. However, like the classic cliched line says, there are two sides to everything. In this case, the bad side is the very obvious set of drawbacks that come associated with running a sole proprietorship company. If you are an aspiring entrepreneur and sole proprietorship is what’s on your mind, you must make sure that you know some of the things we are about to describe.

What Is Sole Proprietorship?

First things first, before we dissect and analyse the characteristics of a sole proprietorship entity, let’s first establish a definition for it. A sole proprietorship is a type of business which is operated under one person or a sole trader. It is a non-legal entity and could even be operated under a fictitious trade name. Eg. Bert’s Coffee Shop, where Bert is not the sole trader’s name. A single person runs and owns the entire business meaning all profits and losses are borne by the trader and nobody else. This roughly translates as – there is no legal distinction whatsoever between the business and the sole trader.

While large scale businesses shy from this type of business entity, it is often the first choice for small to medium scale businesses because of some advantages which are rather difficult to ignore. Here’s why sole proprietorship gets brownie points –

  • Easy to incorporate and equally easy to liquidate
  • Taxation is very simple as it lacks distinction between trader and business
  • Sole trader retains absolute control over the business
  • Cost of formation is minimal

Now let’s address the chief question posed by this article.

What Are The Drawbacks Of A Sole Proprietorship Business?

The disadvantages may be insignificant for those planning to set up small scale trades or businesses run from home. For more serious ventures, sole proprietorship isn’t ideal due to the following reasons –

1. Liability

A sole trader has unlimited personal liabilities. All losses and damages will be borne by the sole trader alone and that could be a vulnerability. Every asset owned by the owner is faced with considerable risk, and any debt, if incurred, must be paid of by the sole trader alone.

2. Growth Potential

Sole proprietorship businesses have very limited growth potential. Most do not grow beyond a certain level and often end up stagnating or getting converted to another type of business entity. In the long run, a sole proprietorship business definitely stunts growth owing to lack of scope for expansion.

3. Capital

Sole proprietorship companies have very limited chances of raising capital. Since banks are hesitant to issue loans to such businesses and also because they generate very little interest in shares, capital is often always coming from the pockets of a sole trader. This potential inability to raise funds, clubbed with limited growth potential leads to very low life spans.

4. Continuation

Sole proprietorship business often dies a natural death following the demise of the sole trader. The business does get passed on to legal heirs in most cases, however, due to the other disadvantages described above, they have very little scope for sustenance.

5. Taxation

Since the sole trader single-handedly runs and owns all finances of the business, (s)he will have to pay all the taxes personally under the self-employed category. Also, if the sole trader passes away unexpectedly, the business might get passed on to the legal heirs putting them in a position where they’ll have to pay hefty inheritance taxes.

Would-Be Entrepreneurs Are Advised To Practise Caution

Starting a company is often a dream for many. While you may have the skills and the resources to give you an edge, bad decision making, especially about the nature of incorporation you wish to begin could put you in hard hitting crisis. We are not saying that sole proprietorship is bad or that it should be avoided. We’re saying and we’re stressing again that any type of business model has a specific purpose. Sole proprietorships are ideal for small scale business and allow the trader to reap all the profits. So if you wish to start a sole proprietorship company, will be more than happy to help you out.

Also, another good alternative to sole proprietorship is the OPC or the One Person Company. Starting an OPC is fairly easy and is pretty similar to starting a company, only slightly simpler. It can be said that OPC combines the ease of incorporation of sole trader while offering the other benefits of a Pvt. Ltd. company.

If you are a would-be entrepreneur facing dilemmas about what kind of business to start, we’re here to help you out on that too. We have unique startup packages and incorporation packages which can help you out with legal documentation formalities involved in setting up a company. Get your legal documentation drafts in order with our online customizable legal documents. Should you need help with anything, do not hesitate to give us a call. Cheers and good luck with for your future!

17 Oct, 16

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