5 Reasons to Avoid Sole Proprietorship
5 Reasons to Avoid Sole Proprietorship
Among some new entrepreneurs, especially those who consider themselves relatively well-educated or already knowledgeable in their business, the temptation to “go it alone” can be substantial. It can create an illusion of complete independence – without relying on others who may be slow to pick up business skills – allowing one to operate as one likes, not infrequently in one’s own house or with limited premises. It can enable ease of starting up since only minimal licenses are required, as well as operation, so tax simplicity and other factors may also be a consideration. In reality, however, most enterprises either start or transition into different kinds, and we will see what the 5 Reasons to Avoid Sole Proprietorship are.
Sole proprietorship
A sole proprietorship is the most straightforward business structure for running a company. It does not entail forming a recognized corporate organization but rather designates an individual as the sole business owner, bearing full responsibility for all its obligations. A sole proprietorship can operate under the owner’s name or a small unbranded name. The unbranded name serves as a trade name and does not establish a separate legal entity apart from the individual proprietor.
The ease of establishment and the low cost associated with sole proprietorship contribute to its popularity as a business structure. A single owner must register their name and obtain local permits to initiate their business. However, one significant drawback of a sole proprietorship is that the owner retains personal liability for all the company’s debts. Consequently, creditors can take legal action against the owner if the sole proprietorship encounters financial difficulties. If such lawsuits are successful, the owner must use personal funds to settle the business’s debts.
Unlimited Liability
The first and most significant disadvantage of a Sole Proprietorship is the unlimited liability that creditors can claim against the proprietor. This arises because there is no distinction between the business and the individual himself. Thus, if the business cannot fulfill any and all of its outstanding financial obligations, these can and will be demanded from the proprietor in precisely the same way as any other individual who has incurred debts and could not pay them off. Thus the liability is both unlimited and personal. This is a primary reason why only a small proportion of businesses opt for being sole proprietorships and prefer to form a LLP or Private Limited Company or One Person Company (each of which, as the name itself suggests, offer a preliminary advantage of limited liability and an artificial distinction, a legal construct, between the individual on the one hand and the company on the other).
Difficulty in Raising Capital
Another difficulty many proprietors face is that of raising capital from private equity, angel investors and other such ventures. The proprietor relies almost entirely on his capital and on borrowed funds to grow the business, as well as reinvested equity from retained earnings. Even banks do not generally lend much to proprietorships as such and subject them to a more rigorous screening process than they would most corporations. This creates difficulties once the business is grown, and gradually as pressure mounts, these factors impel the proprietor to convert his business into a partnership or corporation.
Lack of Financial Controls
Typically, a proprietorship is managed less rigorously than other companies. The looser structure of a proprietorship won’t require financial statements and maintaining company minutiae as a corporation. The lack of accounting controls can make the owner lax about financial matters, perhaps falling behind in payments or not getting paid on time. This can be a severe issue if not strictly managing the financial controls.
Limited Expertise and Growth Potential
This is the other side of the coin regarding working alone or almost alone, especially running the business without an office and from home. Without any less-skilled employees to delegate most of the day-to-day work to, an immense workload is placed on the proprietor. He may have to work all day, and have little time off for family, vacations etc. Moreover, some routine tasks requiring effort throughout the day better suit lower-skilled employees.
Everyone knows Adam Smith’s famous example or observation of a pin to highlight the singular importance of the division of labour on which modern capitalism is based. No one man could easily master, and carry out every day, all the very many and different processes that go into manufacturing a pin even if he spent a great deal of time on it. Whereas with many workers, each of whom knows how to do their own tasks properly, industries very quickly and very efficiently complete the entire process of manufacturing truckloads of pins every hour.
In the same way, and still, more in modern businesses, a delegation of sub-tasks, and lesser important or lower-skilled but nonetheless necessary roles, is an indispensable. Further, there are all sorts of legal, regulatory and financial aspects that are best delegated to others or even outsourced completely to outsiders, who are hired or paid to perform that specific service. Thus, the model of sole proprietorships is ill-suited for many sectors in the industry today, and startups quickly outgrow it and register at least as an LLC or LLP with an office after a few years of running as a proprietorship.
Limited Life and Lack of continuity
Since for all purposes and intents, the business is practically identical to the person himself or herself; proprietors suffer from lack of continuity in the event of sickness, death, default or disinterest among a variety of other factors that can lead to its simple discontinuation. Sometimes, a couple starts a proprietorship, with one person assuming liability. In the event, the original owners are not in interest anymore in carrying on the business, where leave it to heirs.
