Starting a business is a significant step, and in California, a popular choice for new entrepreneurs is to establish a sole proprietorship. While there are several types of business structures to choose from, one of the simplest and most common is the sole proprietorship.
California is home to over 4.4 million small businesses, of which approximately 69.5% are sole proprietorships, which is the most of any state. If you’re ready to join the over 3.1 million successful sole proprietors in the state, this guide will walk you through the steps to legally establish your business.
What is a Sole Proprietorship?
A sole proprietorship is an unincorporated business owned by a single person. It’s the simplest form of business organization to start and maintain, making it a popular choice for first-time business owners. There are no formal setup processes or fees involved in forming a sole proprietorship, which can lower the barrier to entry for many would-be entrepreneurs.
Sole Proprietorship Advantages
Starting a business as a sole proprietorship comes with several benefits. Let’s look at three key advantages:
- Simplicity and ease of formation: Setting up a sole proprietorship is straightforward, with fewer bureaucratic hurdles compared to other business structures. This simplicity allows you to focus more on your business operations rather than on complex legal requirements.
- Tax simplicity: Sole proprietorships enjoy a more straightforward tax process, as the business income is reported on the owner’s personal tax return, simplifying the tax reporting process.
- Inexpensive to form: Compared to other business structures, a sole proprietorship is the most inexpensive to form. There are no state-level registration fees; you only need to pay for any necessary business licenses or permits.
Sole Proprietorship Disadvantages
While there are advantages, it is also important to understand the potential downsides of operating a sole proprietorship. Here, we explore three disadvantages:
- Unlimited personal liability: Sole proprietors are personally responsible for all the business debts and liabilities, which means your personal assets are at risk in case of business debts or lawsuits.
- Difficulty raising capital: Sole proprietorships are limited to using personal assets and credit to fund the business, as they cannot issue stocks or bring in partners.
- Business continuity: Sole proprietorships face issues with continuity, as the business ceases to exist if the owner decides to stop the business, dies, or becomes incapacitated.
If liability protection is a priority for you, considering forming a Limited Liability Company (LLC) might be a better option. An LLC offers better protection of your personal assets compared to a sole proprietorship.
Related: How to form an LLC in California
Steps to Start a Sole Proprietorship in California
In California, establishing a sole proprietorship is relatively straightforward as it doesn’t require formal registration with the state. However, there are essential steps to ensure your business is legally set up. Let’s walk through these steps:
Step 1: Come Up With a Business Name
As a sole proprietor in California, you have the option to operate under your full first and last name or a business name. For instance, if your name is John Doe, you could operate as “John Doe” or “John’s Auto Repair” by a DBA, as shown in the next step.
Step 2: File the Fictitious Business Name Statment Form
To operate under a fictitious business name (DBA), you must file a Fictitious Business Name Statement with the county clerk in the county where the business is located. This allows you to conduct business under a name different than your personal name.
DBA filings in California must be unique or can’t closely resemble other registered names in the county where the business is being registered. Before filing, search the county’s name database, many of which are online, to ensure the name you want to use is available.
Fictitious business names expire five years from filing, according to California Business and Professions Code Section 17920
Related: How to register a Fictitious Business Name in California
Step 3: Get an EIN
Although optional for sole proprietors without employees, obtaining an Employer Identification Number (EIN) from the IRS can be beneficial. It helps keep your social security number confidential and might be required by some banks to open a business bank account.
Step 4: Research Business License Requirements
In California, the process of obtaining the necessary business licenses and permits involves interacting with various federal, state, and local agencies. While there isn’t a universal business license in the state, many cities have their specific requirements based on the business’s location and nature.
For instance, cities like Los Angeles, San Diego, San Jose, San Francisco, and Sacramento have distinct business registration protocols and timelines that you must adhere to. These may involve obtaining a Business Tax Registration Certificate or a Business Operation Tax Permit, depending on the city your business operates in. Moreover, certain businesses in San Francisco, such as food service establishments and tattoo artists, have additional registration requirements with the Office of the City Clerk.
Beyond city regulations, you might also need to secure a California seller’s permit from the Department of Tax & Fee Administration, especially if your business involves selling or leasing merchandise subject to sales tax. If you plan to purchase merchandise to resell, obtaining a California Resale Certificate would be beneficial to avoid paying sales tax on goods meant for resale.
Last, if your business falls under certain professional categories, such as auto repair shops or cosmetology, you will need to obtain a professional license. Detailed information regarding this can be found on the California Department of Consumer Affairs’ website.
Related: What licenses are needed in California?
Taking time to research and understand these requirements will ensure your business operates within the legal frameworks, setting a solid foundation for your entrepreneurial journey in California.