The Internal Revenue Service (IRS) does not recognize a sole proprietorship as a business. The self-employed person lists all income on Form 1040 and pays income tax at the same rate as individuals. Surprisingly, many states do not recognize a sole proprietorship as an entity separate from the individual, even though they represent approximately 75 percent of American businesses. Your options are limited when you want to borrow money with this type of structure. While large and small corporations can issue a variety of bonds to fund expansion, a sole proprietor faces obstacles and restrictions when attempting this method of borrowing.
A regular bond sells at face value and pays a predetermined amount of interest for a specified period. The bondholder receives interest payments at regular intervals throughout the life of the loan. The business repays the face value of the bond at maturity. A sole proprietor may have to offer a high interest rate to attract investors.
A sole proprietor can issue callable bonds. A callable bond is a loan from the investor to the business that the company can redeem, or call, before its maturity date. It usually costs a business more money to pay interest until maturity. If a sole proprietor believes that his business will be able to repay the loan early, then it is in his financial interest to issue a callable bond. He still has the option to not repay the money until maturity.
This is another option for the sole proprietor. Zero-coupon bonds sell at a discount to face value. For example, you might sell a $10,000 zero-coupon bond for $9,000. The bondholder collects the full amount, in this case $10,000, at maturity. The sole proprietorship does not make any interest payments during the life of the bond. Interest is the difference between the discount price and face value. The interest would be $1,000 in this example.
Convertible bonds are financial instruments that an investor can exchange for corporate stock. Since a sole proprietorship is an extension of the individual and not a separate entity, it can never issue stock. Therefore, convertible bonds are not an option for a sole proprietor who wants to borrow money.
Problems Issuing Bonds
Sole proprietors face several problems when issuing bonds. You are completely responsible for repaying the debt, even to the point of losing your home and all personal assets. If you reside in a community property state, then creditors may attach all of your spouse’s assets, even if he or she had nothing to do with your business. Since the business ceases to exist upon your death, potential creditors may make demands that they might not make with a corporation in an effort to recoup their investment. However, the hardest part for a sole proprietor who wants to issue bonds is finding investors who will buy them. Potential creditors will research your background, credit history, financial assets and liabilities, length of time in business, current profits or losses and several other criteria.
Diane Perez is a writer who contributes to various websites, specializing in gardening and business topics, and creates sales copy for private clients. Perez holds a Bachelor of Science in education from the University of Miami.