Starting a Sole Proprietorship? Avoid These 6 Big Mistakes

There are over 23 million sole proprietorships reported in the United States. But despite how common the business entity is, millions of sole proprietors can often make the same mistakes each year.

If you’re considering starting a sole proprietorship and want to understand which mistakes to avoid, then read on. We’ll review the 6 big mistakes that sole proprietors typically may make, how to avoid them, and how to protect your hard work.

Avoid Sole Proprietorship Liability by Avoiding These 6 Big Mistakes

1. Not getting licenses and permits.

While as a sole proprietor, you can start working as soon as you want, it’s important to follow the laws and regulations where you’ll be working.

Depending on which state your business is in and your local municipality, you may be required to have a specific business license or permit when you’re setting up a sole proprietorship.

It may seem time-consuming, but it’s time well spent. Without the appropriate business license or permit to run your sole proprietorship in your state, you could face hefty fines. What’s worse — in some states, you may be forced to close your business altogether.

Imagine going through all the work to establish your business and get operations off the ground, only to find that you can’t continue working.

Curious to know what your state requirements typically are when it comes to getting your sole proprietor business license? Check to see what the requirements are and what the process looks like in our business license hub page here. Since these can change periodically, it is always best to check with your specific state, too.

Beyond staying within the law, getting a business license for your sole proprietorship can also help you attract potential customers. When building your business’s brand, taking steps to build your authority and customers’ trust in you can go a long way.

Having the required business licenses and permits can show potential customers that you take your business and the work you’ll do for them seriously.

2. Not getting business insurance.

Business insurance may not be something that sole proprietors always have on their minds. Especially when you’re starting out, it isn’t easy to imagine making a mistake that could potentially end in a lawsuit.

But it happens. Over 43% of business owners surveyed reported being threatened with or involved in a lawsuit. And remember, you don’t need to be found at fault to have to go through a lawsuit; after all, you still have to defend yourself if you are sued.

In the event that a customer sues you, having business insurance can help protect you by helping to cover requested claim fees or the cost of a lawyer to defend your business (up to your policy limit). We’ll review examples of how business insurance can protect you below.

Similar to getting a business license and the necessary permits, having business insurance can help you build trust with potential customers. But did you know that some states require you to have insurance even before getting your business license?

There are two types of business insurance to consider when you’re starting a sole proprietorship: general liability insurance and professional liability insurance.

General liability insurance typically protects your business from things like:

• Property damage
• Bodily injury
• Third-party accidents
• And more

What could this look like for a sole proprietor?

Say a man owns a lawn services company. He mows the lawn for his client, who loves the quality of his work. But while mowing the lawn one day, a rock slips through the mower and breaks the window of the client’s car parked in the driveway.

The client sues the lawn services business owner for the price to replace the damaged window. Without sole proprietorship insurance with general liability coverage, the business owner may have to pay for a new window out-of-pocket.

For a business of one, those costs, especially together with the cost of a lawyer for defense, could put the lawn services business into debt. With sole proprietorship insurance, though, the business owner could use their policy to cover the window replacement and legal fees, up to the policy limit.

Professional liability insurance typically covers things like:

• Negligence or alleged negligence
• Copyright infringement
• And more

This type of policy could benefit sole proprietor business owners who advise or consult with their clients as a part of their service. Let’s look at an example.

A marketing consultant works for a client, helping them plan their marketing strategy for the year. The client is happy with the work, but the following year, they sue the marketing consultant, claiming that the work they executed didn’t result in as much revenue as they’d predicted.

Without sole proprietorship insurance with professional liability coverage, the marketing consultant may have to pay the requested fees out-of-pocket, as well as any related legal fees.

Paying these fees could negatively impact the marketing consultant’s plans for their business. But if they had sole proprietorship insurance, their professional liability policy could help to cover the fees requested from the client and legal fees, up to the policy limit.

As a sole proprietor, it’s important to note that your personal and business assets aren’t separate from each other. If you get into a legal hot water, it’s possible that the lawsuit could financially impact your personal life and assets, like your car or home.

Fortunately, getting sole proprietorship insurance for your small business can take less than 10 minutes.

Simply Business helps small business owners compare quotes for free with our quote comparison tool.

3. Not filing for a DBA.

As mentioned above, being a sole proprietor means there isn’t separation between your personal and business lives. That means that if your name is Jane Doe, your business name is also Jane Doe and your business and personal life are usually taxed as the same entity – depending on your specific situation.

But what if you don’t want to market your business with your name?

Many business owners choose to use another name to market their business. However, the often-made mistake is that sole proprietors don’t register for a DBA, or a doing-business-as name; it also can be referred to as a fictitious business name.

Say Jane Doe wanted to market her business as Jane’s Tailoring. In this case, her official paperwork would specify that the sole proprietorship is Jane Doe, DBA Jane’s Tailoring.

In order to register a DBA, you’ll need to make sure that the fictitious name you want to use for your sole proprietorship isn’t taken by another company. Once you do that, you’ll have to register your DBA.

If you’re using a DBA and fail to register it, then you could potentially face fines in your city, county, or state. The penalty fines for operating a small business without a DBA differ depending on where your business is located.

Keep in mind that the other DBA-related mistake some sole proprietors make is they don’t realize the name isn’t theirs alone. Just because you register your DBA, doesn’t necessarily mean it’s safe from another business using it. To protect the name for your use, you can consider trademarking it.

4. Not understanding how you’re taxed.

Many sole proprietors enjoy the simplicity of tax season. But when setting up a sole proprietorship, many business owners may not realize that while they’re taxed for their business along with their personal income tax, it’s their responsibility to estimate and withhold their own income taxes.

This means that every time a customer pays you for the work you do, a portion of that should be set aside for your estimated quarterly taxes. The income tax you’ll be required to pay differs, depending on the state your business is in.

For example, Jane Doe is running Jane’s Tailoring, and each time she gets paid by a client, she keeps all the money. When tax season rolls around, if Jane didn’t estimate which percentage of each payment would go to income taxes, she may end up owing the IRS money that she intended to use another way.

However, if Jane puts away a percentage of each pay check into another account, then come tax season, she’ll be prepared if she owes the IRS tax.

It’s best to consult with a tax or accountant professional to discuss your specific business and tax requirements.

5. Not keeping records of taxes and other financials.

Understanding how you’re taxed is one thing not all sole proprietors realize until it’s too late. But another mistake they make when starting a sole proprietorship is not keeping records.

Whether it’s a client contract, an invoice, your Certificate of Insurance, vendor service agreements, lease documents, tax documents, or more, for example — it’s important to keep records. Many small business owners underestimate the importance of staying organized.

Imagine if you were working with a vendor who got acquired and you need to negotiate new terms and conditions of your agreement, but you can’t find the initial agreement; or maybe one year you need to reference an old tax document when filing. It’s important to know how to access information easily.

There’s often so much to do that administrative tasks can easily be swept to the wayside. But when setting up your sole proprietorship, you make a habit of keeping records of your important documents (both hard copy and electronic), you’ll likely be glad you did so down the road.

6. Not applying for an EIN.

If you’re a sole proprietor, there’s a good chance you work on your own and when you file taxes, you likely use your Social Security number.

But what if you decide to hire an independent contractor to help with a specific project?

Sole proprietors who hire temporary workers often make the mistake of not applying for an Employer Identification Number (EIN) with the IRS.

If you need to hire someone to help with any temporary work, or if one day your business grows and you decide to hire a full-time employee, you may need an EIN. If you apply for your EIN when you’re setting up your sole proprietorship, you’ll be prepared if that day comes.

Beyond being able to hire someone, an EIN can help sole proprietors keep a sense of privacy and potentially avoid identity theft. With an EIN, you likely won’t have to worry about giving your customers your Social Security number, which is also tied to your personal identity and accounts.

Avoid Mistakes and Focus on Wins

If you’re starting a sole proprietorship, it’s likely already obvious how much work goes into running a small business. We hope that after reading this article, you understand the big mistakes that could cost you time, money, assets, and even your business.

The great thing about understanding the mistakes others make and the risk they can carry is that you can avoid making the same mistakes. Instead, you can focus on what you’re doing right as a sole proprietorship business owner and all the benefits that being a business owner brings.

To learn more about growing your business successfully, check out Simply U, our blog for business owners.