Sole Proprietorship (Sole Trader)

Definition of the Sole Proprietorship

The sole proprietorship is the simplest and most common legal form in Germany. It is a business operated by a single natural person as the owner. The sole proprietor is the sole decision-maker and owner of the business.

Legally, there is no separation between the business and the owner—the business has no separate legal personality. Therefore, the sole proprietor is personally and unlimitedly liable with their entire assets for all liabilities of the business.

Legal Foundations of the Sole Proprietorship

Depending on the type and scope of the activity, a distinction is made between:

• Small business operators (not registered in the commercial register)
• Registered merchants (e.K.) (registered in the commercial register)
• Freelancers (special legal status)

A small business is a company of limited scope that does not require a commercially organized business operation. Small business operators are not subject to commercial law and are not required to register in the commercial register.

As soon as a business requires a commercially organized business operation, the operator becomes a merchant within the meaning of the German Commercial Code (HGB) and must register in the commercial register. The business is then designated as a "registered merchant" (e.K.) or "registered businesswoman" (e.Kfr.).

Freelancers such as doctors, lawyers, tax consultants, architects, or artists do not need to register a trade and are not obliged to register in the commercial register. They are subject to special professional regulations.

Establishing a Sole Proprietorship

Establishing a sole proprietorship is comparatively simple and involves minimal bureaucratic effort:

1. Trade registration with the competent trade office (not required for freelancers)
2. Registration with the tax office to obtain a tax number
3. Optional: Registration in the commercial register (for commercial business operations)
4. If applicable, membership in the Chamber of Industry and Commerce (IHK) or Chamber of Crafts
5. If applicable, application for necessary permits (industry-specific)

No minimum capital is required for establishment. Costs are limited to fees for trade registration (approximately 15–60 euros) and, if applicable, commercial register entry (approximately 250–300 euros including notary fees).

Business Name and External Representation

There are different regulations regarding naming (business name):

• Small business operators must use their full personal name (first and last name) but may add a descriptive suffix (e.g., "Max Mustermann Web Design")
• Registered merchants have more freedom in choosing their business name and may use fictitious names but must include the suffix "e.K." or "e.Kfr."
• Freelancers must use their name but may also add descriptive suffixes

All business correspondence and websites must include complete information about the owner, address, and contact details. Registered merchants are additionally required to provide their commercial register entry details.

Liability in the Sole Proprietorship

A key characteristic of the sole proprietorship is the unlimited personal liability of the owner. This means:

• The entrepreneur is liable with their entire private assets for all business debts
• Liability also covers claims arising from contractual breaches and damages
• Liability continues even after the business activity has ceased
• There is no possibility of limiting liability in the strict sense

This unlimited liability poses a significant risk, especially in industries with high liability potential. To mitigate risks, sole proprietors can:

• Obtain adequate insurance coverage (business liability, professional liability, etc.)
• Protect certain assets through transfer to a spouse (legally complex)
• Consider switching to a limited liability legal form (GmbH, UG) once the business reaches a certain size

Accounting and Taxes

Accounting obligations depend on the status of the sole proprietorship:

• Small business operators and freelancers with revenues under 600,000 euros and profits under 60,000 euros annually may use the simple income-expenditure statement (EÜR)
• Registered merchants and businesses with higher revenues or profits must maintain double-entry bookkeeping including preparation of a balance sheet and profit and loss statement

Tax-wise, the sole proprietor is subject to the following taxes:

• Income tax on business profits (personal tax rate)
• Value-added tax (VAT) (unless the small business regulation applies)
• Trade tax (for commercial activities, with an exemption threshold of 24,500 euros, creditable against income tax)

Freelancers are exempt from trade tax but must pay all other taxes.

Advantages and Disadvantages of the Sole Proprietorship

Advantages:

• Simple and cost-effective establishment
• No minimum capital requirements
• Maximum entrepreneurial freedom and sole decision-making authority
• Unbureaucratic management
• Direct profit withdrawal possible at any time
• Tax advantages over corporations at low profit levels
• No obligation to disclose annual financial statements

Disadvantages:

• Unlimited personal liability with private assets
• Limited capital-raising options (no equity participation possible)
• High dependence on the entrepreneur (in case of illness, vacation, etc.)
• Limited growth potential due to restricted financing options
• Tax disadvantages compared to corporations beyond a certain size
• No continuation upon the owner’s death without inheritance arrangements

Social Security for Sole Proprietors

Sole proprietors are generally not subject to mandatory social insurance. This means:

• No compulsory membership in statutory health, pension, unemployment, or long-term care insurance
• Self-responsible provision for illness, retirement, and disability
• Option for voluntary health insurance (statutory or private)
• Option for voluntary pension insurance

Exceptions apply to certain professional groups such as craftsmen, artists, and publicists, who may be partially subject to pension insurance. Some freelancers (e.g., doctors, lawyers) have professional pension schemes.

The Sole Proprietorship in Business Transactions

Some particularities apply in business dealings:

• Contracts are concluded directly with the owner, not the business
• All rights and obligations under contracts fall directly on the owner
• Legal proceedings are conducted in the name of the owner
• Employees are personally employed by the owner
• Bank accounts are held in the name of the owner (with the business name added)

For clear separation of private and business finances, a separate business account should be opened, although there is no legal obligation to do so.

Succession and Business Sale

Succession or sale planning for sole proprietorships involves specific challenges:

• The business has no separate legal personality and cannot be transferred as a whole
• Only individual assets can be transferred (asset deal)
• Careful contractual arrangements are necessary for transferring customer bases, contracts, etc.
• Liability risks from the past may remain
• Tax considerations must be taken into account (possible realization of hidden reserves)

Early planning and professional advice are particularly important for business succession.

When Is the Sole Proprietorship the Right Legal Form?

The sole proprietorship is especially suitable for the following scenarios:

• Start-ups with low capital requirements
• Craft businesses and smaller service providers
• Freelance activities (consultants, trainers, artists, etc.)
• Part-time self-employment
• Businesses with low liability risk and manageable business volume

If the business grows, liability risks increase, or partners are to be included, switching to another legal form may be advisable.

Practical Tips for Sole Proprietors

1. Consistently separate private and business finances
2. Obtain adequate liability insurance
3. Ensure sufficient retirement and health provision
4. Build reserves for tax payments and investments
5. Regularly review whether the legal form still fits your business
6. Use professional software for accounting and invoicing
7. Seek regular tax advice
8. Plan ahead for illness or vacation

Conclusion

The sole proprietorship is the simplest and fastest business form to establish, offering maximum entrepreneurial freedom. Its lean organization and minimal formal requirements make it the ideal legal form for start-ups and small businesses.

However, the unlimited personal liability poses a significant risk that becomes increasingly important as business success and volume grow. At a certain point, switching to a limited liability form such as the GmbH or the UG should be considered.

Other legal forms can be found in the articles on AG, GbR, GmbH, GmbH & Co. KG, KG, OHG, and UG.