A guide to sole proprietor business funding
While some businesses rely on employees for the day to day, others are one-person operations. Running a sole proprietorship can simplify things when it comes to filing taxes and tracking expenses. But, it could potentially complicate things if you need to apply for a business loan. Learn what kind of loans are available to sole proprietorships and how to qualify.
What are sole proprietorships?
Simply, a sole proprietorship is an unincorporated one-person business. You, as the business owner, are personally liable for paying taxes for the business and repaying its debts. There’s no distinction between you and the business for tax purposes–the income of the business is treated as your income.
This is the simplest type of company structure you can have, compared to operating as a limited liability company, partnership or corporation. Depending on which state you do business in, there may be no paperwork or filing requirements necessary to operate.
A wide variety of businesses can be run as sole proprietorships. Some examples include:
- Freelance writers, bloggers and graphic designers
- Accountants, bookkeepers and tax preparers
- Food truck owners
- Direct sellers
- Home based business owners
A sole proprietorship structure typically makes the most sense when you’re the only person working in the business. An exception might be if you run a small business and your spouse is your only employee; then, being a sole proprietor could be preferable to incorporating or forming an LLC.
Pros and cons of sole proprietorships
Like any other business structure, there are both advantages and disadvantages that go along with owning a sole proprietorship. Here’s a look at how they compare:
- Sole proprietorships are very easy to set up, with minimal fees and time involved.
- Tax filing is simple. You can file a Form 1040 with Schedule C to report business expenses.
- Since your business is a pass-through entity, you may be eligible for the 20% pass-through deduction on income taxes, which applies to qualified business income.
- Operating a sole proprietorship may be less expensive since you don’t have to pay health insurance premiums or contribute to a retirement account on behalf of employees.
- With no partners or shareholders to report to, you’re in complete control of decision-making for the business.
- Running a sole proprietorship alone can be tiring, mentally and physically, especially if you’re working without the assistance of an independent contractor and handling all business-related tasks by yourself.
- You’re personally responsible for 100% of all the business’s debts and lawsuits. That means if you default on a business loan, a lender could sue you personally or attempt to attach your personal assets to collect what’s owed.
- Taxes tend to be higher than those of corporations and LLCs. There are limitations that apply to the 20% pass-through deduction which may make you ineligible. In addition, sole proprietors pay income taxes and self-employment taxes, and often end up paying more in self-employment taxes.
- If you’re the only person running the business, the business may cease to exist if you become disabled and can’t work, or pass away.
- Getting approved for small business loans may be more difficult if you don’t have sufficient credit, time in business or assets to meet a lender’s minimum requirements.
Financing for sole proprietorships: what are my options?
There are two main categories of financing you may be able to get for your sole proprietorship: debt and equity. Within each category, there are specific funding options you may be able to pursue.
Debt financing for sole proprietorships
In a debt financing arrangement, you’re taking on debt for the business that must be repaid. Depending on the type of financing, you may or may not need to pledge business assets as collateral. The types of debt funding you may be eligible for as a sole proprietorship include:
1. SBA microloans
SBA microloans are designed for new and established businesses that need smaller amounts of funding. The maximum loan amount is $50,000, though according to the SBA, the typical loan amount is $14,000.
An SBA microloan offered by an SBA-approved lender may be a good choice if you have good credit and a relatively small funding need. These loans do require some type of collateral, as well as a personal guarantee making you personally liable for the debt.
The maximum loan repayment term is six years and rates are competitive. Your individual rate will depend largely on your business and personal credit scores.
In addition to SBA microloans, there are several other types of SBA loans that are worthwhile to explore.
2. Business credit card
A business credit isn’t a loan exactly. It’s a revolving line of credit that you can draw against as needed. If you carry a balance month to month, you’ll pay interest on what you spend. You can avoid interest charges by paying in full monthly.
The main advantage of a business credit card for a sole proprietor is that they’re relatively easy to qualify for. It’s possible to open a business credit card account even if your business hasn’t officially launched yet.
Your credit limit and APR will hinge on your credit scores, income and overall financial health. If you can get approved for a rewards business credit card, you may be able to earn points, miles or cash back on purchases, which could save your business money.
3. Business line of credit
A business line of credit works much the same way as a business credit card, without the rewards.
You’re approved for a step credit limit, based on your credit history, income and other factors. You can then draw against your credit limit as necessary to cover expenses for the business.
Compared to a business credit card, a line of credit may be a bit tougher to qualify for as a sole proprietorship. But, you may be able to access a more generous credit limit if you’re approved.
4. Term loan
Term loans allow you to borrow a lump sum of money, which is repaid over a set loan term. Short-term loans typically have repayment terms of 18 months or less, while long-term loans may give you five years or more to pay back what you borrowed.
For sole proprietors, term loans can be found at banks and credit unions but it may be easier to get approved for one through an online lender. Before applying for a term loan for your business, you’ll want to consider the minimum and maximum loan limits, the APR range, loan fees and any other requirements the lender looks for.
As far as what you can use a term loan for, they can cover both near-term or long-term expenses. For example, you may use a short-term loan to cover payroll or pay insurance premiums, while a long-term loan could help you expand into a new location or add to your existing product line.
5. Personal loans for businesses
In some cases, you may be able to use a personal loan for your business. This tends to be most appropriate if you’re just getting started on launching your own venture, or if you have limited operating history and/or revenue which prevents you from qualifying for business loans.
With personal loans, your personal finances determine your odds of approval. Lenders will take into account your credit score, credit history, and income as well as any personal debts.
6. Invoice factoring
Invoice factoring allows you to get a loan based on your outstanding accounts receivable. The lender fronts you the money due for the receivables, then takes over collection efforts.
This kind of financing may be good for sole proprietors that operate on Net 30 or longer payment terms and routinely have unpaid invoices. Just keep in mind that invoice factoring can be more expensive than other types of business financing, since you’re paying a factor fee, rather than an APR.
7. Inventory financing
With inventory financing, you’re leveraging inventory you plan to purchase as collateral for a loan. The idea is that as you sell that inventory, you can use the proceeds to repay what you borrowed.
Inventory financing may work if you run a small retail business as a sole proprietor and need a quick infusion of cash to stock your shelves.
Equity financing for sole proprietorships
Equity financing is a type of financing where you exchange a percentage of ownership in your business for funding. With startups, this usually involves angel investors or a venture capital firm.
In a sole proprietorship, you own 100% of the business. That means that your borrowing options would be limited to using your own assets. For example, you might draw money from your personal savings account, CDs you own or a self-employed retirement plan.
Technically, you’re not sacrificing any ownership stake in the business but this can be a risky way to fund your sole proprietorship. If the business takes a hit, you may not be able to recover any of the personal assets you’ve put into it.
What about friends and family?
If you don’t want to self-fund your business, or don’t have enough money saved to fund your own business, you could approach friends and family about equity financing.
This option requires some careful thought and planning, however. For instance, you’d have to decide how much equity in the business you’d be comfortable giving up. And you’d also want to set the ground rules, in terms of how much control friends or family would have in the business once they invest.
The advantage, of course, is that you’re not going into debt with equity financing from friends and family. There are no hoops to jump through to get approved for a loan and nothing to repay with interest.
How to qualify and apply for a sole proprietorship business loan
If you prefer the idea of debt to equity financing, there are a few things to know before applying for a loan.
How to improve your chances of being approved
Before applying for a business loan, consider viewing your business from a lender’s perspective. The things a lender is most likely to focus on when you apply for a loan include:
- Personal and business credit scores
- Personal and business assets
- Outstanding debts
- Operating history
- Revenues and cash flow
- Your business plan
Then, address the areas you may need to improve to make yourself appear less risky to a lender.
For example, that might mean paying down some of your existing debt to raise your credit score. Or, you may want to consider raising your business prices or offering new products/services to increase revenues.
Also, review your business plan and your reasons for seeking a loan. Make sure that your business plan spells out how the money will be used and the anticipated return on investment.
What you need to qualify
The next step is getting your paperwork together to apply for a sole proprietor loan. This list covers the most important documents you should have ready to share with the lender:
- Tax returns for the previous two years
- Bank statements for the previous two to three months
- Cash flow statement
- Profit and loss statement
- Balance sheet
- Collateral documentation if you’re applying for a secured loan
- Updated business plan
If you can’t readily provide these types of documents, then you may need to reconsider your business loan options. For instance, you may have to look into getting a personal loan or personal credit card instead.
How to apply for a sole proprietorship loan
Not all business lenders provide funding to sole proprietors. Once you’re ready to apply, take time to compare lenders to review loan terms, interest rates and fees for the type of funding you’re interested in. Then, check the lender’s minimum requirements for a loan, including whether a personal guarantee is necessary.
Complete the loan application and upload all of the supporting documents the lender asks for. Be sure to include multiple ways to contact you so the lender can stay in touch.
Business loans for sole proprietorships from Funding Circle
Funding Circle offers business loans for sole proprietors ranging from $25,000 to $300,000 to meet a variety of needs. Rates are competitive starting at just 4.99% with terms ranging from six months to 5 years. You can apply for a loan online in just 10 minutes, and get a decision in as little as 24 hours after document submission.
A loan from Funding Circle could help your sole proprietorship meet a variety of needs, large or small. Apply today to get a personalized quote for your next business loan.
Why should I borrow from Funding Circle and not someone else?
- We offer competitive rates, manageable repayment schedules, and provide each applicant with a dedicated account manager to guide you through our quick and easy online application. Our fixed rates start at just 4.99%, and because we believe in an honest, transparent borrowing experience you’ll know exactly how much you have to repay each month with no hidden fees or prepayment penalties.
Do you offer loans for startups?
- We like to support all kinds of entrepreneurs, but our focus right now is on helping established small businesses grow and thrive. To qualify for a loan on our marketplace, you must be in business for at least two years.
What can I use my business loan for?
- You can use your loan in a variety of ways to support your business. Popular uses for a Funding Circle loan include expanding to a new location, purchasing equipment or inventory, and hiring staff. Your loan may not be used for your personal finances, such as refinancing of personal debt.
What factors do you consider in your underwriting process?
- We know that a credit score isn’t the only indicator of a healthy business, so we consider a number of other factors when considering a loan application, from real-time cash flow to online customer reviews.
What documentation is required with my application?
- 2 most recent years of business tax returns
- 1 most recent year of personal tax returns
- 6 most recent months of bank statements
- Business debt information
- Signed guarantor form for any owner with 20%+ ownership of the business