The Step-by-Step Guide to Setting Up a Sole Proprietorship

Laura Holton

Laura is a professional writer specializing in content aimed at small businesses and entrepreneurs. She has helped countless startups find the information they needed to take their ventures to the next level.

One of the most popular ways to establish a new business is through a sole proprietorship. In fact, three-quarters of all businesses in U.S. are sole proprietorships. These are popular because they’re easy to set up and give the owner full rights over decision making.

 

What Is a Sole Proprietorship?

A sole proprietorship is only one type of business — others include various types of corporations and limited liability companies (LLCs). However, unlike these other kinds of businesses, there’s no need to register a sole proprietorship to bring it into existence. The only requirement is that you’re the only person working at the business. If you want to expand later to hire employees, it is easy to transition to an LLC or corporation.

Since there is no registration for a sole proprietorship, you and your business are the same entity for legal and tax purposes. The advantage of this is that it’s much simpler than running another type of business. For instance, all your business profits become part of your personal income and you report them as profits on your personal income tax return.

The main disadvantage to this model is that you’re personally liable if you’re sued or if you owe money, meaning creditors can use your personal assets in payment for debts. Plus, you’ll still need to make sure you possess all the necessary permits and licenses to operate.

What Kinds of Businesses Are Best Suited for Sole Proprietorships?

Anyone who works as a freelancer or independent consultant as well as business owners who have no partners or employees are sole proprietors. Some of the most common types of businesses that fall into this category include:

  • Web designers and developers
  • Digital marketers (including SEO, branding, and PPC specialists)
  • Housekeepers and landscapers
  • Personal trainers
  • Writers
  • IT professionals
  • Home carers
  • Graphic designers
  • Accountants and financial planners
  • Photographers
  • Tutors
  • Event planners

Types of Sole Proprietorships

There are three main types of sole proprietorships.

First, you have independent contractors. These are self-employed individual who work for clients. They receive contracts and carry out work to clients’ terms, but they are able to choose who they work with.

The second type is business owners. Again, they work with clients, but they are less likely to receive exact instructions on how to carry out tasks.

Third, you have franchisees. They receive their name, branding, and business model from a franchisor in exchange for royalties.

How to Set Up a Sole Proprietorship

Since no formal registration is necessary, there’s no need to do anything to turn your business into a sole proprietorship. In fact, you may already be a sole proprietor without knowing it! In this case, it’s extra worthwhile making sure you’ve carried out all the necessary steps, as this will help you gain the full benefits from your sole proprietorship and prevent problems.

Step 1: Decide If a Sole Proprietorship Is Right for You

Before you go any further, you need to be sure that a sole proprietorship is the right option for your business. The main alternative to consider is an LLC, which gives you liability protection and allows you to shift ownership to investors.

It tends to be easier to raise capital for an LLC, as this can help you appear more professional. However, you will need to go through some additional steps to set up your business (including paying an average of $1,000). Plus, filing taxes is more complex and you may owe more.

If you do decide a sole proprietorship is the right choice, continue to the following steps.

Step 2: Run a Risk Assessment

When running a risk assessment, consider if there’s any potential for your business to cause someone harm that could lead to you being sued. You can then take action to mitigate these risks. For instance, if you’re selling food, how could you minimize the chances of someone suffering food poisoning? If you’re an IT professional, how will you prevent data breaches?

Step 3: Choose a Business Name

Unless you have a franchise, you’ll need to pick a name. Many sole proprietorships use the business owner’s name for their names. You can even add the type of business to the end of your name — you still won’t need to register it. However, if you want something other than your legal name, you will need to take some additional steps.

For one thing, you’ll need to find out whether the name is already taken. You can search for names at the United States Patent and Trademark Office (USPTO). Consider registering your choice to make the trademark belong to you.

Make sure all the words you want to use in your name are allowed in your state. Many states restrict you from using terms like “bank,” “trust,” and “insurance.”

Finally, if your business name differs from your legal name, you’ll need to register it as your “doing business as” (DBA) name. This will prevent anyone else in your area from being able to do business under the same name.

Whatever you choose — your legal name or otherwise — don’t come to any final decisions until you’ve checked that you’ll be able to purchase the domain name. The last thing you want is to sort out all the paperwork, only to find that you need to use something completely different for your website. In fact, you should steer clear of anything that is even similar to an existing domain to avoid confusion.

Step 4: Write Your Business Plan

To guide your business in the right direction to meet your goals, it’s worthwhile having a business plan. This should include an analysis of your competitors as well as details about your target clients, the resources you’ll need, expenses, your mission, and your objectives.

Step 5: Apply for Any Necessary Licenses and Permits

Depending on the type of business and where you want to operate, you may need to gain certain licenses, permits, and training before you can begin. If you’re unsure what applies to you, contact your local Small Business Development Center (SBDC).

Some types of licenses and permits you may need include:

  • A premise permit
  • Regulated activity permits
  • A health department permit
  • An occupational license
  • Health and safety training
  • Official certifications

Step 6: Set Up a Business Bank Account

Separate your business finances from your personal finances by setting up a dedicated business bank account. If you have a DBA name, use this for your bank account. You can also take out a business credit card just for business expenses, although you should only do this when you already have a good credit history. Otherwise, you’ll find that interest rates are extremely high and you could end up in debt.

In addition, you’ll need to create a record-keeping system to monitor your business finances. This will help you calculate profits, know your cash flow, and assess which business activities are leading to the greatest returns. You’ll also need accurate records to pay your taxes.

Step 7: Pay Estimated Taxes

Sole proprietorships that owe more than $1,000 in income tax should make estimated tax payments to the IRS to avoid penalties. Once you’ve established your business and have a clearer idea of what you owe, you can adjust what you pay to be a more accurate amount. You’ll need to pay at least 90 percent of what you end up owing on your tax return to avoid penalties.

Step 8: Take Out Insurance

As you saw above, the main risk of having a sole proprietorship is liabilities. To protect yourself and your assets, it may be necessary to take out several types of insurance.

At a minimum, obtain disability insurance. In the case something happens to you and you’re unable to work, you’ll receive income through your policy.

If you operate your business out of your home, you should also research property and liability coverage. Often, homeowner’s policies don’t cover business activities, meaning you need to take out a separate policy or expand your current coverage. The same applies to car insurance: if you’re using a personal vehicle for business, you may need to extend the coverage.

Finally, don’t forget about health insurance. If you’re quitting your job to start your own business, you’ll either need to take out your own health insurance or check if you can be covered by your spouse’s plan.

Step 8: Outsource Support

Even running a sole proprietorship requires a large amount of dedication and it can be difficult to manage everything on your own. Since you’ll have to become an LLC to hire someone, a better option is to outsource the work you are unable to do yourself.

Contracting a virtual assistant allows you to hand off all your admin tasks along with things like bookkeeping, social media, and marketing. This leaves you free to focus on your core business functions. Receive a 5-percent discount on virtual assistant services from MYVA360 by using this coupon.

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