6 Disadvantages of a Sole Proprietorship – Forbes Advisor

A sole proprietorship is an unregistered business owned by one person. When you operate a business as a sole proprietorship, there’s no distinction between you and the business (as there is with a limited liability company or corporation, for example). 

Sole proprietorship is the default ownership structure for a business of one, and it’s the simplest way to organize your business when you’re getting started. But it has some drawbacks to consider, especially as your business grows. As you decide how to structure your business now and in the future, keep in mind these potential disadvantages of a sole proprietorship. 

1. No Financial Separation

Because a sole proprietorship isn’t a separate entity from you as the business owner/operator, there’s no separation between your personal assets and finances, and those of your business. Your home, savings and other personal assets are on the line for purposes such as taxes, loan applications, debts and legal liabilities. 

For some workers, this lack of separation simplifies money management. Filing taxes as a sole proprietor is much simpler than filing for a business entity, for example.

But it also makes it hard to prove your income for things like mortgage applications, health insurance subsidies or other benefits. A sole proprietor usually has to provide a previous year’s tax return as proof of income, which could be wildly inaccurate if your income fluctuates year to year. If you organize an LLC and pay yourself as a W-2 employee, you get pay stubs like any other employee, which often receive less scrutiny as proof of income. (You’ll need to file your taxes as an S-Corp to be able to do this, but more on that below.) 

2. No Legal Distinction

The greater financial risk of sole proprietorship is dealing with legal liability. If you’re in a line of work with a risk of being sued or you owe a business debt, your personal assets are all on the line. 

With a registered business entity, the entity owns the property, supplies and bank accounts for your business, while you separately own your individual assets. As a sole proprietor, everything falls into the same bucket. Your home could be taken to fulfill a business debt, or your personal savings drained to pay out a lawsuit. 

You could add legal protection as a sole proprietor by purchasing small business insurance designed to pay out in case of a liability. However, this doesn’t cover business debts. Before taking out a business loan, get crystal clear about the assets that guarantee the loan and what happens if you’re unable to repay on time. 

3. High Payroll Taxes

Sole proprietors pay the payroll taxes of both an individual and a small business. Your income taxes are similar to what you’d pay as an employee (minus any business-related tax deductions for costs you can’t claim as an employee). But payroll taxes—the money deducted from your paycheck toward Social Security and Medicare—double when you’re self-employed. 

In traditional employment, an employer pays half of Social Security and Medicare taxes, and an employee pays the other half, automatically deducted from your paycheck. When you’re self-employed, you pay the whole thing: 15.3% of your income (up to the Social Security taxable maximum, which is $176,100 for 2025 earnings). 

Reorganizing a sole proprietorship as an LLC doesn’t change this tax responsibility. But it gives you the option to be taxed as an S Corporation, which lets you pay yourself a salary as a W-2 employee. In that case, you only pay payroll taxes on your salary, but as a sole proprietor, you pay payroll taxes on all revenue into the business. This option is more complex, but it becomes attractive to small business owners as revenue increases beyond what you’d typically earn as an employee doing the same work. 

4. Harder to Get Funding for Growth 

Sole proprietors often look riskier to lenders than registered businesses, which could make it tough to be approved for a business loan. Even if you have the income to cover debt repayment, the lack of financial separation between you and the business might make it difficult to prove that on paper to a lender. 

Operating as a sole proprietor also makes it tough to take on investors. You can’t give investors ownership shares in the business if you want to remain a sole proprietor. If the business has multiple owners, it automatically becomes a partnership. You don’t have to register the business, but you should draft a partnership agreement with any co-owners (even silent partners) to dictate the terms of ownership and business management. 

You do have some funding options that let you retain full ownership. You could borrow money from family or friends with an official lending agreement. Or you could use a crowdfunding campaign to solicit preorders from customers and offer creative incentives, like brand swag or special events, in exchange for their early support. 

5. Perceived Lack of Professionalism

One reason many business owners opt for a registered business entity is to increase their perceived legitimacy with customers, vendors and partners. Operating under a business name ending in “LLC” and providing a business tax ID number might suggest a more serious and successful business than simply operating under your personal name. 

You can address this concern without the complexity of registering a business, though. Instead, register a DBA (“doing business as”) name with your state (also called a fictitious or trade name). It usually costs around $10 to $20 one time, and there’s no effect on your tax treatment. 

As the name suggests, a DBA lets you do business under your registered name. You can list the DBA on legal and financial paperwork, such as contracts, bank accounts and loan applications. 

If you want one more step of separation, you can also apply for an employer identification number (EIN) for tax purposes without registering a business. This doesn’t change your tax filing status; it just lets you file under the EIN instead of your personal Social Security number. 

6. Challenges With Business Continuity and Transfer of Ownership

A sole proprietor business might be harder to transfer to a new owner than an LLC would be. An LLC is a cohesive entity for which you can create a continuity plan (such as an heir) or transfer in whole to a new owner. A sole proprietorship doesn’t contain such an entity; instead, it’s made up of individual assets and goodwill. 

As a sole proprietor, you can sell those assets and goodwill individually, called an asset sale. This is how I bought a local print shop from a sole proprietor in 2023. The assets (machines and materials) were priced individually, as was the “goodwill”—i.e., the reputation and relationships with customers—and the DBA name. All of those made up the total sale price, and ownership was transferred to my partner and me. However, none of the previous owners’ financial history carried over, as it would if we’d bought a business entity with its own credit history. 

What Are Some Advantages of a Sole Proprietorship? 

Despite these disadvantages, a sole proprietorship is the right structure for a lot of small business owners. Sole proprietorship advantages include: 

• No registration required. You’re automatically treated as a sole proprietor for legal and tax purposes; you don’t have to register the status with your state or the IRS. That keeps things simple and lets you avoid ongoing registration fees and maintenance. 
• Simple taxes. Sole proprietors file taxes using form 1040, just like other individuals. You might file additional IRS forms, depending on how your business operates, but taxes are generally simpler for sole proprietors than other business structures.
• Limited regulatory obligations. States often aren’t set up to service businesses of one. Once you register a business entity, you might get lumped into regulations and processes designed for much larger, more complex companies. That could mean added costs or added work navigating a complex system to exempt yourself from such requirements. Operating as a sole proprietor lets you avoid this complexity if regulations don’t apply to your business. 
• 100% ownership. Being the sole owner of the business means you retain complete control over its operations and own 100% of its profits. 
• No franchise tax. A few states charge an annual tax to registered businesses that can be burdensome to solo business owners. In most cases, the tax is around $200 to $300, but California’s annual franchise tax is the most notable at a minimum of $800.

Alternatives to a Sole Proprietorship

If you’re worried about navigating the disadvantages of a sole proprietorship, consider these alternative types of business ownership:

• Partnership: If you have investors or co-owners, you could operate as a general partnership. Like a sole proprietorship, this structure is automatic and doesn’t require registration. 
• Limited Liability Company (LLC): As a solo business owner, you can get legal separation from your business by registering a single-member LLC. This limits your personal liability and comes with tax benefits. 
• Corporation: For even more distance from your company, you could incorporate the business. A corporation is a much more complex type of business entity with greater tax obligations and governance requirements. It’s not usually a fit for a single-owner business, but it might be attractive if you have partners or want to raise money with options for a variety of investors.

Choose the Right Business Structure for You

As soon as you start doing business—whether as an online freelancer or a brick-and-mortar retailer or anything in between—you’re automatically a sole proprietor. Understanding the financial, legal and tax implications of that business structure compared with others will help you set up your business in the way that makes the most sense for your personal and business needs. 

A sole proprietorship is an attractive option for many solo business owners, including freelancers and other service providers. It lets you work for yourself without the costs and complexities of maintaining a business entity. But it comes with disadvantages, especially for growing businesses. As you decide how you’ll run your business now and in the future, determine whether a sole proprietorship or another business entity best meets your needs.

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