A sole proprietorship is the most basic form of business -- where the owner is in business for himself as an individual without outside partners or the complexities of any corporate structure. Accordingly, the sole proprietorship operates as an alter ego of the owner, not as an independent legal entity. This gives rise to various types of risk to the sole proprietor in the course of business.
A vendor or customer can sue a sole proprietor personally. This risk lasts for as long as the claim is valid (until the statute of limitations expires), even after the sole proprietor closes down the business.
A creditor can sue a sole proprietor personally for unpaid debts. If successful in court, the creditor can collect a judgment from the sole proprietor's personal assets.
If the business fails, the sole proprietor cannot simply put the business in bankruptcy. He would have to file personal bankruptcy to get relief from the sole proprietorship's business debts.
Read More: Can Business Assets Be Touched if You File Personal Bankruptcy?
All business credit activity goes on the sole proprietor's personal credit report, which can hurt his personal credit rating.
A business background check or any formal due diligence conducted on the sole proprietorship business may bring up items including customer complaints, regulatory findings and court filings. Since an individual sole proprietor is so closely intertwined with the sole proprietorship business and the sole proprietorship is operated under the owner's name, these findings may hurt the owner's personal reputation as a result.
An Internal Revenue Service audit of the sole proprietorship business means that the IRS will also audit the owner's entire personal income tax return, since there is no separation of the business from the owner as in a corporation.
Proof of Income
Banks and other creditors view sole proprietors as being self-employed, and this can make it harder to provide necessary proof of income to obtain or increase credit.
For various reasons, a sole proprietorship does not have the same level of professional creditworthiness as a more formal corporation or limited liability company. Thus, it can be harder for a sole proprietorship to get business credit from lenders. Nonetheless, a sole proprietor is free to use his own personal credit or savings to fund the business as he sees fit.
If the owner of the sole proprietorship dies, the business ends. There is no easy way to transfer ownership and maintain business continuity since everything is in the individual name of the sole proprietor.
Access to Capital
A sole proprietor has no way to raise outside equity capital. As a sole proprietor, he cannot take on partners or sell shares to raise money without the complicated and expensive process of changing the legal structure of the business.
Jeff Clements has been a certified public accountant and business consultant since 2002. He has also worked in private practice as an attorney. Clements founded a multi-strategy hedge fund and has served as its research director and portfolio manager since its inception. He holds a Juris Doctor, as well as a master's degree in accounting.