Pros and Cons of a Sole Proprietorship
Now, let’s talk about the pros and cons of operating a business as a sole proprietor.
On the plus side, a sole proprietorship is easy to set up and the cost is minimal. You won’t invest a lot of time or money on a legal business structure that may not work out.
You can literally start operating as a sole proprietor just by doing business and then including those activities on your income tax return, both state and federal.
Now, the list of reasons on the negative side of a sole proprietorship.
As I said, if you are actively conducting business as a sole proprietor, there is no legal separation between you and your business activities. With no separation between you and your business, then you are PERSONALLY liable for all your business activities, including any and all debt incurred. Obviously, this can pose significant risk for you and your family.
If you are personally liable for all your business activities then your personal assets can be targeted and possibly seized if there is a judgment against you or your business for any reason. Most states have laws that define what personal assets can and cannot be seized. But, at a minimum, a judgment will most likely seize your personal bank accounts and can seize other personal property as allowed by the state. You don’t want that to happen.
An example of this might be if your product fails and causes someone personal injury. Then, the person injured sues your business, since there is no legal separation between your business and yourself, then in effect that person is suing you and a judgment can and WILL require you to be personally responsible for that debt.
This goes both ways as well. If you end up being sued personally then your business assets can be seized in a judgment. An example of a personal legal proceeding that could jeopardize your business assets would be a divorce. In the case of a divorce in a community property state, those assets would be considered your personal assets and can be included in what is divided up in the final divorce decree.
So how do you decide if a Sole Proprietorship is the right choice for you?
I have started multiple businesses as sole proprietorship and then I evolved those business structures by forming LLCs.
If you are just starting out with minimal resources, and your product or service doesn’t involve items or advice that can cause harm to your customers, then you should be okay to operate as a sole proprietor while you are just starting out. Establish a DBA, open a business checking account and keep all business financial activity separate and track it in detail.
However, if, as a sole proprietor, you provide software development services for clients that could impact their business if not done properly or you sell any type of product that could cause injury, like the hot coffee incident with McDonald’s, then you need to move to a different structure as soon as possible. A business structure that provides some level of liability protection.
And that structure would be a limited liability company.
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