Choosing a business structure is one of the most important decisions a new or growing company makes because it impacts everything from liability to taxes. On this page, we’ll do a deep dive into sole proprietorships, including the top drawbacks and benefits of sole proprietorships and how they stack up to other options.
Types of Business Entities in Canada
Before we dig into the drawbacks and benefits of sole proprietorships, let’s quickly review the four types of business entities you can form in Canada.
Sole Proprietorships
The business and its owner are considered the same entity in a sole proprietorship.
Partnerships
Partnerships work like sole proprietorships but consist of more than one owner.
Corporations
A corporation is a legal entity distinct from its owner or operator. Businesses may be incorporated at the federal or provincial level.
Cooperatives
Cooperatives can be for-profit or not-for-profit. They work similarly to corporations and may be registered at the federal or provincial level. However, they’re distinct in that they’re organized and controlled by their members.
Drawbacks of Sole Proprietorship
There are advantages and disadvantages associated with each type of entity. Let’s explore some of the drawbacks of sole proprietorship first.
1. You’re Personally Liable for the Business
Because the business and business owner are one and the same in a sole proprietorship, the owner is liable for anything that might happen with the company. That means the owner’s personal assets, such as home and vehicles, may be on the line if the business doesn’t fulfill its obligations. It also means the owner is liable for an incident involving the company. For instance, if a customer slips and falls on business property or suffers a loss due to the business’s products or services, the owner will likely be held personally liable for damages.
2. It’s Difficult to Secure Funding and Credit
Many investors and banks will only lend to or invest in incorporated businesses. Even if a sole proprietorship can obtain a loan, it’s usually at a higher rate than a corporation pays. Plus, corporations can raise funds in ways sole proprietorships cannot, such as by selling shares or bonds to investors.
3. Taxes Are Usually Higher
The business’s profit is considered your income when you operate a sole proprietorship. That’s not necessarily bad when your business is small and doesn’t earn much profit. However, it can become expensive as your business grows because high-income individuals are taxed at a higher rate than corporations. There will come a point in which you pay a higher tax rate as a sole proprietorship if you successfully grow your business.
4. It’s Harder to Sell the Business
Sole proprietorships are not distinct from their owner. That means there’s no business or shares to sell if you decide to exit. Sole proprietors sell business assets to get around this, but it’s done piecemeal. For instance, you might sell your trademarks, database, or equipment. Business debts don’t necessarily transfer with them. You must negotiate every portion. This makes the process difficult and often messy.
5. Your Business May Cease to Exist When You Pass Away
A sole proprietorship ceases to exist if something happens to the owner. You can create a line of succession to address this, but many business owners don’t, and their legacy ends with them.
Benefits of Sole Proprietorships
Despite these negatives, there are some benefits of sole proprietorships that make them one of the most popular legal structures for small businesses.
1. There’s Less Paperwork
One of the greatest advantages of a sole proprietorship is that paperwork is minimized. For instance, if your annual revenue is under $30,000 and you’re doing business under your legal name, you might not need to file at all, as BDC reports.
2. You Keep All the Profit
The business’s earnings before tax (EBT) are considered the owner’s income with a sole proprietorship and don’t need to be shared with anyone. The owner isn’t even allowed to pay themselves a salary because it’s all considered theirs.
3. You Maintain Control of Your Company
A corporation must have a board of directors with at least one director and officers, including a president and secretary. While it’s technically possible for one person to hold all these roles, a fair amount of reporting is still involved. These rules don’t apply to a sole proprietorship.
4. Accounting is Simpler
Corporations have ongoing disclosure requirements, including sharing specific financial statements throughout the year. This aspect can be complex, so most business owners must hire an accountant to manage it all. Sole proprietorships don’t have the same requirements. Those with basic financial literacy and/or good accounting software can typically manage it without external help.
5. There Are Fewer Tax Requirements
For the most part, a business owner with a sole proprietorship will keep filing taxes like they always have. However, a separate section outlines the business’s profit and loss that must be completed too. Filing taxes as a corporation is entirely different and usually requires the help of a tax professional. The business, itself, pays taxes, and you pay taxes based on your income separately.
Bottom Line: Should You Open a Sole Proprietorship?
There are a few reasons to open a sole proprietorship rather than incorporate. For instance, if you operate a low-risk business, expect it to stay small, and want to maintain total control, the business structure can work for you. If you’re planning to grow, believe your business may need funding later, or want more protection for your personal assets, incorporating may be better.
Help Your Small Business Get the Funding it Needs to Grow
If your business is experiencing cash flow gaps due to slow-paying clients or it’s expanding, and you need help covering everyday expenses or growth-related initiatives, an invoice factoring company may be able to provide you with advance payment on your B2B invoices. Businesses primarily qualify based on the creditworthiness of their clients because they’re the ones paying the invoices, so it’s easier to get approved. Request a complimentary rate quote to learn more or get started.
