We will kick off this series with the simplest, most widely used business structure, the sole proprietorship.
What Is a Sole Proprietorship? A sole proprietorship is simply a single individual engaged in business activity. The 2012 U.S. Census of Agriculture reports that nationwide, just over 86% of farms are sole proprietorships. In Texas, that number is even higher at 90%.
Governing Law: Unlike the other entities we will discuss in this series, the sole proprietorship is not governed by statute. There is no provision in the Business Organizations Code to govern sole proprietorships.
Formation: Unquestionably, a sole proprietorship is the most simple business structure to set up as there are no filings or fees required. A person may simply start up his or her business. If the business will be conducting business in a name other than that of the owner, legally termed “doing business as,” a DBA certificate must be filed either with the county clerk in the county where the premise is maintained or, if no business premise is maintained, in all counties where business is conducted.
Management/Decision-Making: This business structure gives the manager the greatest level of managerial flexibility and control, as he or she is free to manage the business as desired. There are no limitations or requirements on how management is to be conducted or how decisions are to be made.
Liability: The major downfall of sole proprietorships is the fact that there is no limit on liability for the owner. Thus, the sole proprietor, as well as his or her personal assets, are at risk for liability in the event that a claim is made. For example, if a farm is operated as a sole proprietorship and the farmer is involved in an automobile accident, all of the farmer’s assets–personal and business–are in jeopardy if a suit is filed and judgment entered.
Tax Treatment: Another potential concern related to the sole proprietorship is the fact that all business earnings are treated as personal income for income tax purposes. Additionally, the business owner’s income is subject to self-employment taxes.
Termination of Business: Because the sole proprietorship is owned only by one person, the death of the owner constitutes the end of the business. This makes it much more difficult for a sole proprietorship to transfer between generations. Statistics show that only about 30% of family businesses survive to the second generation, only 12% to the third generation, and only about 3% continue in operation beyond the fourth generation. All farms, and especially those operating as a sole proprietorship should have a detailed transition plan in place.
Summary: The sole proprietorship is the most common business entity. The main benefits are the ease of creation and flexibility in management. Major downsides of the sole proprietorship is the unlimited personal liability and difficulty in the generational transfer.