“Starting a company as a sole proprietorship takes no set up beside figuratively ‘hanging out your sign’ and possibly obtaining a fictitious business name. Of course, there are multiple things you should do, in addition, but starting a company as a sole proprietor is the easiest way to go,” says Kristen Hayes Kuse, attorney at Integrated General Counsel.
A sole proprietorship is the default company structure you will assume if you’re doing business and haven’t set up any other business type. According to the U.S. Small Business Administration (SBA), 73% of small businesses in the U.S. are sole proprietorships.
Furthermore, 24.6 million people conducted nonfarm sole proprietorship activity in 2014, according to the Internal Revenue Service (IRS). As Kuse said, you don’t have to do anything to start a sole proprietorship besides conducting business, but there are steps you need to take to make your business a successful one.
How to start a sole proprietorship
Here’s everything you need to know about this company structure and its implications.
1. Write a business plan
Even though you don’t have to formally set up your business as a sole proprietorship, it’s still a business and, the more organized it is, the better your chances are of reaching success.
Noel Damacio, Certified Public Accountant, says, “Write a business plan and projections – this will force you to be familiar with the financial numbers so you can determine the profitability and viability of your business. It will also help you identify your market and competition and how you are going to position yourself to generate the revenues.”
Francine Love, Founder and Principal Attorney at LOVE LAW FIRM added, “If you don’t have the patience and the ability to complete this full analysis of your market, your skills, your money, your pricing, your competitors, etc., then how will you ever run a money-making operation? ”
2. Build your credit
Next, build your credit. When running a business, you’ll often reach a point where you need to invest in your business in order to grow and expand your operation. With a sole proprietorship, your access to funds is often dependent on your credit.
AJ Saleem started his tutoring company as a sole proprietorship and says, “My number one tip is to build up a great credit history before actually starting the business. You will often be strapped for cash, and while credit cards allow you to access a lot of loans quickly, you will often be hit with a lot of interest charges.”
A better option is to look into personal loans. There are many online personal loan lenders which have made borrowing much more accessible and convenient. Even if your credit score is subprime, you may be able to get approved, but, the better your score, the cheaper it will be to borrow.
If you’re curious about what you qualify for, try Supermoney’s loan prequalification tool. By answering a few quick questions, you can get personalized offers from various lenders, without negatively impacting your credit score.
3. Get the necessary permits and licenses
There are various permits and licenses required by federal, state, and local governments depending on your type of business. These are separate from the establishment of your business structure.
Mark Chatow, small business attorney at Chatow Law says, “Get your business licenses immediately. Most cities require any business, even a sole proprietorship, to have a business license. He adds, “The penalties for operating without a license are typically much higher than the cost of obtaining and renewing your license each year. You will also typically need your business license to open a bank account and obtain insurance coverage.”
Furthermore, Chatow offers advice on specialized permits saying, “Get any industry-specific licenses you need. Depending on where you live, everything from construction to cosmetology may require that you qualify for and obtain a state license to operate your business.”
He warns, “The penalties for being unlicensed can be extremely harsh. For example, in California, if you are an unlicensed construction contractor you could be forced to give back any money you made performing construction services while unlicensed. If you’re practicing a trade of any kind, check with your state, county, and city to learn their specific licensing requirements.”
You can check the required licenses or permits for your state, county, and business type here and should also contact the Small Business Development Center (SBDC) in your city for detailed information.
4. Consider registering a fictitious business name
Sole proprietors will, by default, do business in their own name. For example, if your name is John Smith and you are a web designer, your business name would be John Smith. If you want your name to be something else (i.e. JS Web Designs), you need to register a fictitious business name (FBN), also sometimes known as a “doing business as”(DBA) name.
Chatow says it’s a good idea because “failing to file your DBA or FBN can prevent you from filing or defending lawsuits and can create confusion with other businesses that may have a similar name.” When picking your name, it’s important that you choose a name that isn’t being used elsewhere.
To help ensure your name is unique, “Check the business search section on the secretary of state website for your state to make sure there’s not another business using your business name for their business entity.” says Chatow, “You should also check the United States Trademark Office (USPTO) website, where you can search for federally registered trademarks.”
How do you register your name? “The requirements vary from state to state but (name registrations) are typically done at the county level and involve registering for your business name and publishing a notice that you are doing business under that name,” says Chatow.
He also adds that, if you file your own federal trademark registration with the USPTO, it will help to prevent others from using your name. He says, “If you don’t, you may still have some limited protection depending on your state, but you’ll have much stronger protections if your mark is registered federally.”
Note that filing a fictitious business name isn’t required in all states, so check with your local SBA office.
5. Open a bank account
Next, it’s highly recommended to get a bank account exclusively for your business. This keeps your personal and business finances separate, making it easier to keep track for yourself as well as for anyone else you share your business finances with (i.e. investors, lenders or the IRS).
Maddy Osman, Founder of The Blogsmith says, “One of the most important tips for starting a sole proprietorship company is to separate your business finances from your personal spending. This will be incredibly helpful when it comes to accounting/bookkeeping and eventual tax preparation.”
She adds that “In the case of an audit, it can be reassuring to know that the IRS will only be auditing business accounts and not your personal assets. It’s also helpful to know how much of your expenses relate to your business, and how that compares to (/is separate from) personal expenses.”
Abby Eisenkraft, CEO of Choice Tax Solutions Inc. adds, “A sole proprietorship is a business in the eyes of the IRS, and it should be in your eyes, too. This means no commingling of business and personal funds (unless you want a problem with the IRS).”
6. Prepare for tax season
One of the most important things to know about the business structure you choose is how it impacts you when tax time comes around. Charles Vethan, Founder and CEO of Vethan Law Firm, says, “Since a sole proprietorship is a disregarded entity, you would report business income (i.e. your personal income) on Schedule C of your personal income tax return each year.”
He adds, “When you’re running a sole proprietorship, you’re expected to pay a self-employment tax in order to satisfy Social Security and Medicare tax requirements.” This differs from other business structures, such as a corporation or limited liability corporation, where the business is a separate tax entity.
Because taxes are not withheld from your earnings throughout the year, you’re expected to make quarterly estimated payments to the IRS. Eisenkraft says, “Be prepared to pay quarterly estimated taxes if you are profitable and you expect to owe the IRS more than $1,000.” Then, at the end of the year, you may have to pay more or may get a refund depending on how accurate your estimations were.
It’s not just federal taxes you need to think about. Sole proprietor Mark Brinkerhoff advises, “Learn your state’s franchise tax laws. Depending on which state you live, you likely will have to file a state franchise tax return (usually in the neighborhood of $100 annually) that will ensure your business is legally authorized to do business in the state.”
To avoid accidentally overlooking any required tax steps, check your state and local tax laws here.
7. Minimize liability
Another main factor in choosing a business structure is the liability you assume. As a sole proprietor, you are your business and your business is you. If you are sued and found liable, you will be personally responsible for paying the settlement.
Chatow says, “If someone gets injured at your location or because of your work or products, you could potentially personally lose everything.” This means that any and all assets you have are at stake; this is actually a primary reason people choose a business structure that separates the business from the owner.
However, if you do want to start a sole proprietorship, Chatow advises, “Business insurance is one of the best and most cost-effective ways to ensure that if something happens you’ll be covered.” Insurance types, such as general liability or errors and omissions policies, can help to provide the protection you need.
Chatlow also warns “Pay attention to relevant business laws. Many sole proprietors are so busy focusing on their businesses that they forget that business laws apply to them too. Most sole proprietors get into legal trouble when they ignore labor laws or don’t think that environmental regulations apply to them.”
Here’s a few more tips from sole proprietor Steven Hausman, Ph.D. and President of Hausman Technology Consulting.
- Consider getting a tax id number from the IRS (Not required, but can be beneficial. Hausman says, “You will need to supply a W-9 form when submitting any invoices for payment. I would much rather have a Tax ID number on that form than my Social Security number for fraud prevention purposes. It also seems more professional if you have a Tax ID rather than using your personal SS number.”)
- Contacting Dun and Bradstreet and obtaining a DUNS number (“This is a unique nine-digit identification number for each physical location of your business. Obtaining the number assignment is free for all businesses required to register with the federal government for contracts or grants.” says Hausman)
- Set up a website
- Make business cards
- Set up an office (whether at home or outside the home)
- Set up social media accounts for the company (LinkedIn, Facebook, Twitter)
- Establish association memberships
- Open a PO Box
- Purchase tax software or hire an accountant
Start growing your sole proprietorship company
A sole proprietorship is easy to start up compared to other business structures. Also, it’s perfect for the business owner on a solo venture. You can make all of the decisions and will have total control of the direction your company goes in.
However, you need to be aware of several implications, such as the full liability you hold, tax responsibilities, and the legal requirements for your business. Keep this list on hand as you start up to ensure you have covered your bases and start your sole proprietorship company on the right foot.
If funding is your main obstacle to getting starting, review and compare personal loan lenders below.
Jessica Walrack is a personal finance writer at SuperMoney, The Simple Dollar, Interest.com, Commonbond, Bankrate, NextAdvisor, Guardian, Personalloans.org and many others. She specializes in taking personal finance topics like loans, credit cards, and budgeting, and making them accessible and fun.