Disadvantages of Sole Proprietorships
1. Unlimited legal liability
There is no legal separation between the owner and the business. Similar to how all profits flow to the owner, all debts and obligations rest with the proprietor.
If the business cannot satisfy its obligations, creditors may pursue the proprietor’s personal assets in order to be repaid.
This accountability is clearly outlined within legal documents signed with lenders, sometimes called a promissory note. A proprietor does not need to provide a personal guarantee to their sole proprietorship, as the two are the same legal entity in the eyes of the law.
2. Limit to available capital
Owners put their own resources to bear when going into business for themselves. There are limits to their financial resources and the amount of credit they get when they seek out lending relationships.
Proprietors cannot sell shares, or interest, in their business to raise money.
Putting ideas into reality is risky and can be costly. Keeping a business going can be capital intensive. Some expenses must be incurred before revenue is generated. Any sales on credit, and any cash paid towards expenses, must be financed by working capital. Equipment and other long-use resources required for the business must be rented or financed.
If business requirements exceed the resources and financing available to proprietors, they will need to closely manage their working capital and potentially curtail the acquisition of fixed assets.
A fulsome business plan helps proprietors determine the capital necessary to start up, sustain, and grow the business.
3. Backup and succession
If the owner cannot or does not want to operate the business, it stops. An owner may have a family member or trusted employee who can briefly work in place of the owner in the case of illness or any temporary and unforeseen reason.
Business interruption insurance may cover expenses for longer-term issues, but these policies cannot complete the work that a proprietor has already taken on.
Without a separate legal identity, sole proprietorships cannot readily pass any intangible assets from one owner to another. Aside from equipment and fixed assets, the value of the business is inherently tied to the proprietor.
To make any sale attractive, a proprietor must find someone with comparable skills willing to purchase the goodwill the owner has built up. If they cannot find a buyer, the proprietor may pass the business on to a family member or a trusted employee if one exists.
4. Skills and experience
The proprietor must make “good enough” decisions in all business areas. If an owner does not have enough knowledge or skills, their decisions may be flawed. There is a finite amount of time to do things correctly or learn to do everything adequately.
It can be difficult for individuals to manage all aspects of their business properly. The owner can hire employees, outside help, or get professional advice on parts of the business process.
The owner’s ability to use their own time to earn greater profits to offset the cost of hiring help is a crucial consideration.
Employees, contractors, and other services may be too costly for such sole proprietorships. The owner’s time must be productive enough to
pay for the cost of hiring others.
