As of now, there are 30.2 million small businesses in the US. According to a survey, 20% will survive year one while half will close shop come year five. For those that do succeed, it is all too common to hear the standard business advice: transition to a more formal business structure—limited liability company (LLC) or a corporation (S or C). (However, while sole proprietorship is the most common business structure, not all small businesses are sole proprietorships.) But are there situations where it is actually in a business owners’ best interest not to? Better yet, should some businesses switch back to a sole proprietorship? When should you and when shouldn’t you? Read on to find out! (Plus, read more on why you may want to consider doing a South Dakota entity search.)
Going Back to Your Roots: When Businesses Benefit as Sole Proprietorships
Below are several reasons why businesses may want to consider transitioning back to a sole proprietorship. However, please know that each business is different; we recommend that you discuss this option with a business coach and/or financial advisor to determine if this is the best course of action for you.
1. Not Making Enough Money
Based on your projections, you thought you’d hit higher sales figures than you do now. With this in mind, the amount of paperwork and higher registration costs and fees, let alone the number of shareholder meetings you need to record (if you run a corporation) may not be worth the small revenue stream trickling in.
Another reason business owners transition to an LLC or corporation is the amount of money they can save on taxes; S corporations, in particular, have the option of allotting roughly 60% (or more) to salary, and the rest (usually 40% or less) to distributions, which will not be taxed. Businesses that are not making enough money may not get to leverage this pro enough. As The New York Times states, sole proprietorships are the simplest (and most common) business entity to set up; business owners with out-of-hand businesses may benefit scaling back and “starting from scratch.”
2. You Do Not Expect Business Growth—And You Are Fine with That
Not every small business owner’s goal is to be the next Bill Gates or Mark Zuckerberg; to be honest, most probably would want another vacation, as a survey revealed that 60% of small business owners take one vacation a year and nearly one-quarter (23%) enjoyed less than two vacation days.
Maybe you want to reach an income number that comfortably provides you the basics? The number of hours in the office — 29% of small business owners clock in 50 plus hours of work per week — may not be worth the possibility of running a multi-million-dollar organization. If you are not looking to scale up (and you have the limited liability coverage like business liability insurance in place), maybe a sole proprietorship is the right move for you.
3. You Want Complete Control
If you don’t want shareholders or board members influencing your business (two musts if you are in a corporation), you may benefit from transitioning back to a sole proprietorship. One of the many benefits of a sole proprietorship, as The New York Times states, is complete control over decision-making processes. While this can be a double edge sword—you are responsible for debts and, without liability coverage, your business assets are vulnerable to seizure—you have full control over your business’ future, from brand to product or service changes.
3 Misconceptions: When It Looks Like You Should Become a Sole Proprietor
While there are some situations where transitioning back to a sole proprietorship is obvious (i.e. not enough revenue…), in some cases you may want to think twice. Below are three; of course, as we mentioned earlier, it comes down to your business, specific financial environment, and future business goals.
Misconception #1: You Only Need a Couple Employees So Sole Proprietorship It Is!
One misconception is assuming you need to scale back to or remain a sole proprietorship if your business does not require that many employees. Remember, a small business does not automatically mean sole proprietorship. Basecamp, for instance, is a small business registered as an LLC. With roughly 50 employees, the small business brings in $25 million plus in revenue, making it a small giant.
Misconception #2: You Don’t Want to Go Public…Ever
The 90s saw thousands (7,322 IPOs in 1996, to be exact) of companies go public. At the time, the business world gave the golden star of approval to companies with an IPO status. It signaled financial and social success. Nowadays, we are seeing more companies taking the IPO leap—however, don’t expect the same outrageous figures.
But does this mean every C corporation needs to—or should—go the IPO route? The simple answer: not necessarily. Non-IPOs can easily acquire the same wealth as IPOs. Long story short, if you don’t want to go public, you don’t have to. Deciding on that does not mean you need to become a sole proprietorship..
Misconception #3: You Don’t Have the Venture Capital Funding You Want
You need funding but for whatever reason venture capitalists are not nibbling. But this does not mean you should transition to a sole proprietorship; in fact, some venture capitalists won’t go near sole proprietors simply because they cannot offer shares or stakes in their business. Know that out of roughly 1,000 US companies, only about 400 make it to Series A funding. That doesn’t mean the rest call it quits; businesses the get the door slammed from venture capitalists, can turn to angel investors, grass roots fundraising, donations from family and friends, and personal loans.
Final Thoughts: Transitioning to a Sole Proprietorship Is Not Back-Tracking
If you do decide to make the transition to sole proprietorship, know that you are not back-tracking. Part of running a business is making the smart decisions now that will enable future business growth: if this means filing as a sole proprietorship, you are in the right direction. In order to make the best decision for your business, we suggest discussing options with experienced business coaches, financial advisors, CPAs, and even your business attorney. Have other tips? Leave a comment.