Why a Sole Proprietorship May Be Best for You

Today, LLCs (limited liability companies) seem to be the favored form of business organization and they do offer a lot of advantages. But for many small startup businesses there is a lot to be said for having no business organization at all, which is referred to as a sole proprietorship.

Sole proprietorship

First what is a sole proprietorship? Basically, it means that there is no legal distinction between you and your business. The income that the business earns is part of your personal income. A sole proprietorship would not have a separate balance sheet since it is not a legal entity: the sole proprietorship does not have assets or debts. Instead you personally own the assets and are responsible for the debts that the business incurs.

What’s the biggest problem with having a sole proprietorship? Because there is no distinction between you and the business, you are automatically liable for all of the debts and obligations of your business. In essence they are your debts, since the business is not a separate legal entity. This means if someone trips and falls in your business and they are looking for someone to sue, they will sue you personally. If the court awards a payout then you will be obligated to use all of your personal assets to pay the legal obligation, even though it was incurred in the activity of your business.

However, in real life you are probably going to have business insurance anyways, that would cover you up to a certain amount in the case of someone being injured in the workplace. What about liability for bank loans? Wouldn’t it be nice to have the protection of an LLC or Corporation in case you are not able to pay back your back loans? Nice try! Until your business becomes highly established and extremely profitable, your bank is going to insist that you, and likely your spouse if you have one, personally guarantee your bank loans if you are doing business as a corporation or LLC.

Shop owner

A lot of people have told me that it just sounds more professional to do business as an LLC or a Corporation. Even my very first business attorney told me this. So, what! I would rather save the cash if I’m running a very small startup. An LLC or a Corporation will involve more accounting work and it will involve filing reports and paying annual fees to the state that you are incorporated in, and the states that you are doing business in.

What about having a basic partnership with another person. Isn’t that pretty much the same thing as a sole proprietorship? Yes and no. You and your partners will pay taxes personally based on your share of profits or losses in the partnership. Like a sole proprietorship there is no distinct legal entity. But there is an important pitfall to watch out for in participating in a partnership.

If you start a 50/50 partnership for example, you might assume that you are responsible for 50% of the debts or obligations of the partnership if you get into trouble. Not so! You would each be responsible for the entire debt and obligations of the partnership. This means if you start a partnership with your buddy Joe and Joe buys a new car in the name of the partnership on credit from a car dealership, then you could be held responsible for the entire car loan.

Business partnership

Another problem with a partnership, especially a 50/50 partnership, is how do you make a decision if the partners are in disagreement? I remember my grandmother would from time to time buy land parcels with her sister, and then when her sister decided that she wanted to sell that my grandmother would have to go along, even though she wanted to hold out and sell the land at a later point in time.

It is worth giving some time to think about what kind of legal entity you want to use for your business. Get all the information you can. Get your attorney’s advice. Then make your own decision. There is nothing wrong with doing business as a sole proprietorship if you understand the risks and the tradeoffs.

About the Author: Bob Adams, serial entrepreneur and founder of BusinessTown.com


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