5 Reasons to Avoid Sole Proprietorship
Among some new entrepreneurs, especially those who consider themselves fairly well educated or already knowledgeable in their business, the temptation to “go it alone” can be strong. It can create for an illusion of complete independence – without having to rely 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 allow ease of starting up, since only minimal licenses are required, as well as of operation, so tax simplicity and other factors may be a consideration as well. In reality, however, a majority of enterprises either start off or transition into other kinds, and we will see why below.
The first and most important disadvantage of a Sole Proprietorship is the unlimited liability that can be claimed by creditors against the proprietor. This arises from the fact there is no distinction between the business and the individual himself. Thus, if the business is unable to fulfill any and all of its outstanding financial obligations, these can and will be demanded from the proprietor, in exactly the same way as any other individual who had incurred debts and was unable to 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 in a less rigorous manner 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 result in the owner being lax about financial matters, perhaps falling behind in payments or not getting paid on time. This can be a serious issue if financial controls are not strictly managed.
Limited Expertise and Growth Potential
This is the other side of the coin when it comes to working alone or almost alone, especially if business is carried out 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 through the day, have little time off for family, vacations etc. Moreover, some routine tasks which require effort throughout the day may be better suited to lower-skilled employees.
Everyone knows Adam Smith’s famous example or observation of a pin to highlight the singular importance of 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 know 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, 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 considered to be 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 married couple starts a proprietorship, with one person assuming liability, and in the event the original owners are not interested anymore in carrying on the business, it is either left to heirs, or in some cases may be sold.
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