Are you starting a small business and pondering whether to register as a sole proprietorship?
As an entrepreneur in Canada, you can run a business as a sole proprietorship, a corporation, or a partnership. There are advantages and disadvantages to all three types of business structures. Deciding which structure is right for your business depends on various factors, including personal liability and tax deductions. If you plan to run the business all by yourself, being a sole proprietor may just be the right decision. At least for now. It’s the simplest kind of business structure in Canada, as it is an unincorporated business that is owned by one person. So, what are the pros and cons of sole proprietorship?
PROS of Sole Proprietorship
Starting out lean? Registering your one-person business as a sole proprietorship is a lot cheaper to register than a corporation. You can choose to register a business name or operate under your own name. If you decide to operate under a registered business name, you will bill your clients and customers in the business’s name. Keep in mind that if your business has a name other than your own, you’ll need a separate bank account to process cheques payable to your business. Unlike with an incorporated business, you won’t have to make annual filings. In Ontario you will have to renew your sole proprietorship business registration every five years. You’ll have to remember to renew the registration since the government will not be sending you a reminder.
As a self-employed sole proprietor, you’ll pay personal income tax on the net income generated by your business. You’ll be declaring your business income on your personal income tax form, rather than having to file a separate tax return. You’ll pay personal income tax on your business’ earnings minus business expenses, as well as contributions to the Canada Pension Plan (CPP). The maximum amount a self-employed person can contribute to CPP is $5,796 a year as of 2020. You can also contribute to Employment Insurance (EI), if you wish. It’s completely voluntary. As of 2020, the EI rate for self-employed individuals is 1.58%. So, for every $100 you earn, you would need to pay $1.58, to a maximum of $856.36 a year (or maximum insurable earnings of $54,200). insurable earnings refers to your gross salary, or your business revenue after you’ve deducted business expenses, but before you’ve paid any income tax and CPP. You can lower your average tax rate and your taxes by taking advantage of other personal tax deductions and tax credits, such as claiming some of your RRSP contributions as deductions. The reason why many choose to operate their business as a corporation instead of a sole proprietorship is to defer and save taxes. Business tax rates are lower than personal tax rates.
Work environment? As a sole proprietor you will be able to create a work environment that is comfortable for you. Work hours? You’ll be able to choose your own schedule. Decisions? You’ll make all of them and choose your work projects on your own timeline. New challenges? Forget any boredom you had as an employee, there will always be new challenges as you work to grow and expand your own business. Income opportunities? If your business is successful you’ll probably be making more money than you did as an employee.
CONS of Sole Proprietorship
All The Liability
The biggest disadvantage to being a sole proprietor is assuming all the liability of the company, unlike a corporation where the owner(s) enjoy liability protection, which limits risk to the amount they have invested in the business. Assuming all the responsibility makes it much easier for someone to go after your personal assets if the business defaults on debts. Since the company doesn’t exist as a separate entity, all personal property and any riches are directly linked to the business. That being said, having a sole proprietorship is a simpler, yet flexible way to scale operations.
Difficulty Raising Funds
For many small creative service businesses, staying lean and growing organically is the way to go. But what if you have cash flow issues? Sometimes bootstrapping just isn’t enough. As a business owner, you want your business to grow and take advantage of opportunities. You’ll have to work through appearing as a ‘less professional’ business to some people, in relation to an incorporated company. With a sole proprietorship, finding potential investors and raising funds is not simple. Incorporated companies are able to raise money more easily, which would make it easier for your business to grow and expand. Investors feel more secure in their investment when it comes to a business that’s a separate legal entity.
It’s all on you, baby! Be prepared to work longer hours and have less free time. Although you get to choose your own hours, you’ll probably end up working more hours than you did as an employee. And, unlike in a business partnership, you won’t have anyone else to run ideas by or to give fresh insight. No one else will know or care as much as you will. You have less security as a sole business owner, and you’ll feel it. Although no one can fire you, if the business is having financial problems it will affect you directly. It’s possible that you will make less money than you thought you would and may not be able to have the business survive.
Sometimes, the loose structure of a sole proprietorship results in a laissez-faire attitude when it comes to tracking business expenses and preparing financial statements. And since you’re running a business on your own, you may not have enough time to track and separate business and personal expenses. When you’re starting out, professional bookkeeping services may seem like an indulgence, a perk that can be added once cash is flowing or the business has reached a certain size. But a bookkeeper is actually the first pro your business should partner with. Why did you start your business? Not to keep your books. Spend your time doing what you love to do, not trying to make sense of the numbers with a free accounting software.
Hiring a bookkeeper for your creative business will keep you organized with tracking expenses, as well as organizing receipts, processing invoices, and doing cash flow summaries. But a bookkeeper doesn’t just maintain your business’s financial records and document its transactions, they prevent any red flags or audits. A quality bookkeeper pays attention to detail, is willing to track down every tiny detail and never forgets a task.
Do The Pros Or Cons Win Out?
With good planning and consideration of the pros and cons of sole proprietorship, this business type can be a great success. It is the simplest and least expensive business structure. It’s affordable to set up, simple tax-wise, and includes many freedoms. In the future, you can always add a business partner or choose to incorporate. When you’re ready to more easily access capital, share losses, and have financial control over a business that can endure for perpetuity, then set up a corporation. We can help with that.