Choice of Entity
Choice of Entity - The Sole Proprietorship

The Sole Proprietorship

The simplest business form is the sole proprietorship.  In a sole proprietorship, an individual person conducts business and holds title to property in his or her name and is directly and personally liable for the obligations of the business.  There are no formalities required by law to form a sole proprietorship.  As there is only one participant in the business, i.e. the sole proprietor, there are no organizational documents setting forth the rights of participants in the venture.  In addition, there is no public filing requirement for organizing a sole proprietorship. 

Where a sole proprietor does not foresee participating in the venture with other owners nor plans on sophisticated financing, the ease of formation allowed by the sole proprietorship may be the best choice.  By choosing this form, a sole proprietor may engage in any business as in other forms.  Sole proprietors may hire employees, but this give rise to personal liability for the tortious acts of employees on the basis of agency theory of liability.

The sole proprietorship is usually the least expensive business entity to form, because there is no requirement to draft organizational documents, and there are no required public filings.  While there may be a cost associated with filing fictitious business name documents, this cost is low.  The continuing maintenance costs of the sole proprietorship are also low because it is not subject to statutory reporting and record-keeping requirements.

The organization and operation of a sole proprietorship is governed by no specific statute.  Rather, the rules of contract, torts, property, and agency govern the business.  In addition, there may be specific regulatory restrictions on the business of the sole proprietorship in the jurisdiction where it is located.

One of the drawbacks of the sole proprietorship is that there is generally no continuity of business beyond the death or incapacity of the single owner.  The business instead will usually be liquidated subsequent to the death of the owner.  Liquidation is accomplished by either selling the assets of the business or by selling the business itself as a going concern to another person.
Because the sole proprietor is a party to contracts and maintains other individual obligations that support the operation of the venture, it is relatively difficult to transfer interests in the sole proprietorship where the proprietor holds title to assets.  In the corporate form it is much simpler to transfer interests, where this is accomplished simply by transferring the securities of the business.   Creditors of the sole proprietorship may restrict transfer of interests to third parties as well.  Thus, if continuity of existence or transferability of interests in the entity are essential requirements of the founder, the sole proprietorship generally should be avoided.

Converting the sole proprietorship to another form of entity may be sought where a venture has moved past its research and development stage.  At that point, the sole proprietorship may be converted into a partnership or corporation thereby allowing capital contributions from investors.  Alternatively, a sole proprietor may find it beneficial to admit co-owners into the venture so as to build a management team.  Converting from a sole proprietorship to a corporation also extends liability protection to the owner.  Although there are tax and other legal issues associated with converting the sole proprietorship to another form, it is the simplest form of business to convert to other entities.