Disadvantages of a sole proprietorship
As with any business structure, there are disadvantages to sole proprietorships as well. Here, we look into the two biggest risks—liability and difficulty raising capital.
Personal liability
The same way sole proprietorships afford you the freedom to operate as you see fit—adhering only to licensing mandates without registration or shareholders—this freedom comes with responsibility. As a sole proprietor, you are personally liable for paying contractors, honoring debts, paying the necessary taxes and insurance for your employees, and any legal contingencies.
If your sole proprietorship is sued for malpractice or bankruptcy, for example, your personal assets including your home, cars, and bank accounts can be seized to cover these expenses. This differs from other business structures, in which a business is legally separated from its owner and there’s no risk to personal assets if an employee is injured, the company is sued, or debts aren’t repaid.
Even if you’re an individual freelancer, it’s important to be aware of self-employment taxes that must be paid to cover Social Security and Medicare.
Difficulty raising money
The personal liability of a sole proprietor represents risk and, for this reason, banks can be hesitant to lend money or issue credit under this business structure. It’s also more difficult as a sole proprietor to generate buy-in from investors, as the company is not formally recognized and is not designated to have shareholders.
Consider alternative financing options, like bootstrapping and crowdfunding, at the outset. Bootstrapping a business is relying on personal savings or company sales for funding, rather than outside investors. Crowdfunding, on the other hand, is financing a business through many small donations or investments through a platform like Kickstarter or Indiegogo. Adriana Vazquez did market research before launching a Kickstarter for her company Lilu, which makes an innovative breast pumping bra.
“Before we started Lilu, we sent out a survey to a handful of moms with a few questions about pumping equipment and products,” Vazquez told Ideas by WeWork. Vazquez raised $33,377 for her first run of bras on Kickstarter.
“The next morning, we had more than 500 responses from moms with one particular gripe: Breast pumping sucks—and we realized it was worth investing time and effort into redesigning that experience,” said Vazquez. “A crowdfunding campaign was an option because we knew that there was a strong community of people who wanted to see change in this space.”