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Small Business

Risks of Being a Sole Trader – Advantages & Disadvantages of Sole Proprietorship

min read

If you’re thinking of going into business for yourself, you’re probably excited about all the benefits of sole proprietorship. 

Whatever field you’re in, starting a new business as a sole proprietorship means freedom. From setting your own hours to building your own client list, being your own boss has a number of advantages. Like anything else in life, though, it’s not without risk. What are the advantages and disadvantages of sole proprietorship, and is it the right choice?

Risks of Being a Sole Trader

Fortunately, there are ways to overcome the challenges of sole proprietorship. 

To survive and thrive as your own boss, it’s important to understand what they are and then make a proactive plan to address them. Here’s a deeper look at the most common sole proprietorship risks.

Sole Proprietorship Liability

Unlike an LLC or a corporation, a sole proprietorship opens you up to personal liability for things that go wrong within your company. 

Injury liability and liability for property damage are especially big risks, as a big lawsuit could not only bankrupt your company but also wipe you out personally. Fortunately, business insurance can help.

At Next Insurance, we offer customized policies that can grow with your business. General liability insurance covers physical injuries, property damage, advertising harm, and most other common business concerns. You can also bundle professional liability insurance, which covers professional mistakes. 

Commercial auto insurance is an easy and inexpensive add-on that provides coverage when you or an employee use your vehicle in the course of business.

Lack of Legal and Financial Knowledge

Ignorance of the law is not an excuse for not following it. 

Some of the most difficult small business challenges are centered around legal and financial matters. Sole proprietors have fewer document requirements than other types of businesses, but they can still be challenging.

At the very beginning, before ever opening your doors, you will need to file a great deal of startup paperwork. Depending on exactly what products or services you offer, you may need a business license, one or more certifications, IRS filings, and a variety of other legal documents. Each year, you will need to file federal and possibly state income taxes. You may be responsible for collecting sales tax and paying it to the relevant agency in your area on a monthly basis.

You will also need to keep up with your company’s bookkeeping and accounting. This means tracking all of your sales and returns, creating profit and loss statements, and even forecasting future growth. Making even a small mistake can throw off an entire year’s records, lead to errors on your tax returns, and cause you to make poor decisions on how to grow the business.

Fortunately, though the legal and financial challenges of sole proprietorship can be tough, there is no need to handle everything alone. A variety of software solutions are available to walk you through every step of the process. In addition, attorneys and tax professionals with extensive knowledge of sole proprietorships are easy to find. 

It’s worth making the investment in having an expert help you file your startup paperwork and go through your books at least once a year.

Limited Opportunities for Investment and Growth

Unless you are already independently wealthy, raising money will likely be an ongoing challenge until your company reaches consistent profitability. 

Even once you start to turn a profit, it can be difficult to get ahead of the constant treadmill of maintaining enough inventory to fulfill orders.

All small businesses face these rough spots, but those with multiple partners often find it easier to pull together enough cash to get some traction, since each partner can contribute a portion of the total amount needed. As a sole proprietor, it is well worth looking into alternative funding sources. Venture capitalists, angel investors, small business loans, and even crowdsourcing can be excellent ways to get unstuck and grow your business to the next level. 

Of course, you will need a strong growth plan to present to potential investors, so if business development isn’t your strong suit, you may want to consider bringing in a consultant short-term.

Lack of Time and Expertise

No matter how good you are in your field, it’s impossible for any one person to be equally skilled in all aspects of running a business. 

In addition, one of the risks of being a sole trader is that you are responsible for literally everything: selling, managing returns, making appointments, dealing with vendors, paying the bills, marketing the company, building the brand, steering business growth, and so much more. There are only so many hours in the day, and it is inevitable that some tasks will fall by the wayside.

Thankfully, there is no need to be a one-person show. Both paid and unpaid help is everywhere, just waiting for your invitation to come on board. Begin by tapping into your personal network. Is your aunt an excellent photographer? Maybe she would be willing to take a few action shots for your website. Does your best friend know everything there is to know about sales? Ask him to help out when you hold a big event.

For bigger tasks, such as setting up your IT or creating your brand, consider looking to the experts. Consultants don’t work for free, but they may be more affordable than you thought, and a short-term investment can pay off in a huge way.

Putting It All Together

All new companies face a certain level of risk, and there is no reason to dissuade yourself from becoming a sole trader before you even get started. Instead, it’s important to go into business with your eyes wide open. Small business risk management begins with a simple risk assessment.

Sit down and make a list of the activities in which your company will engage, break them down into tasks, and think about the things that are most likely to go wrong. Then start building a plan to protect yourself if those events should come to pass. Most of the time, everything will go reasonably well, but having a plan for the challenges of sole proprietorship is the key to minimizing your risk.

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