Any form of business organization you can think of has some its advocates and disadvantages. The same case is echoed in a sole proprietorship business. Disadvantages of sole proprietorship inform sole traders of challenges and drawbacks to expect in their venture.
Disadvantages of Sole Proprietorship
1. Unlimited liability:
The owner is fully liable for any debts of the business. A sole trader’s money is the final resort if the business cannot meet its financial liabilities.
Unlimited liability could bring much trouble to the owner when their finances can only cover a portion of their business debt. If creditors decide to take a legal suit, the owner is sued in their personal capacity. Being sued in a personal capacity implies the owner will lose their asset if the court decides that creditors should go ahead and use such assets and try to recover their money.
2. Limitations on capital raising:
Unlike corporations and partnerships, sole proprietorships have minimal sources of raising capital. Corporations can get capital from banks quickly because they have collaterals. On the other hand, sole proprietorships rely on savings and friends and family. Raising money through bank loans is as hard. Often, they might not have substantial security to qualify for a bank loan.
A sole proprietorship business may not be as convincing to investors. Rarely do potential investors commit their money to this form of business. Investors often hesitate to risk their funds in such ventures due to a lack of proper documentation, a lack of a detailed marketing plan, and an absence of contingency planning.
3. Sole trader takes all risks:
The owner of this business will take several risks to achieve success. Taking risks solely to venture into business may lead to bankruptcy unless well managed. This happens when such ventures demand sizable start-up capital. The possibility of bankruptcy is brutal, among other disadvantages of sole proprietorship.
Despite taking risks, the sole business owner bears all losses of their business. If the sole trader does not keep financial records, they could make losses without even noticing it. It drains their energy and wallet in the long run before they picture the dwindling financial health of their business.
4. No perpetual life for a sole proprietorship:
Another disadvantage of sole proprietorship businesses is that the owner’s death will lead to the end of the business. The life of such a business venture is dictated by the life of the owner and their good health.
At times, a sole proprietorship business will die for other reasons, not necessarily the owner’s death. For instance, some health complications might immobilize the sole trader. They end up neglecting their sole venture to focus on improving their health and battling prevailing illnesses.
If the owner dies and the heir of the business’s assets tries to run the sole proprietorship left behind, they have to start it afresh. Without a proper understanding of how different business functions works, such business inevitably declines.
5. Established on shaky financial grounds:
When starting a sole proprietorship, the sole trader often ignores the need for financial projections. They start their business without considering the possibility of their start-up delaying making profits until they’re one year into the business. They lightly evaluate how they will fund their business for such a long time before they start making substantial revenues.
When financial turbulence comes, sole travel starts to lose market traction. Without external funding and contingency planning, survival proves harder.
For instance, the Covid-19 pandemic sunk many sole proprietorships. This is due to the devastating financial and emotional magnitude of the pandemic. Some sole proprietors were overwhelmed and sent out of business indefinitely.
6. Heavily relies on active income:
The sole trader must be present in their shop to earn revenue. If they do not report for a day, it goes to waste as no sales are made. Some may avoid this by having someone in their shop attend to customers on their behalf.
Despite having such a person, the whole model of generating revenue is active. A person has to work for the sole proprietorship to generate revenue. This demand for a sole trader or helper to actively sell products from their shop is called active income. The inability to scale up this business for passive income is dominant among other disadvantages of sole proprietorship.
7. Could miss professional management of some business functions:
A sole trader could venture into business because they are good at marketing, for instance. However, business success is a conglomerate of accounting, customer service, and finance, just a few to mention.
When the sole trader solely relies on their single skill, say marketing, to operate a successful business, their vision fails to convert. Professionalism missing for other business functions barricades success.