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Sole Proprietorships – What, Why, and How?

Updated: Feb 19

By far the most common business entity in the United States is the sole proprietorship, generally between 70% and 75% of all businesses. It's easy to form, simpler to operate, but there are serious drawbacks. We'll take each issue in turn.


What is a sole proprietorship?


A sole proprietorship is the easiest entity to "form." If you're operating a business by yourself, and you have taken no steps to form an entity, you have a sole proprietorship. Congratulations!


(Note: The reason "form" is in quotes is because you aren't really forming anything separate and distinct from yourself).


Bear in mind that the business has no existence apart from you. You are the business.


Why remain a sole proprietorship?


The business's income is your income. You pay business taxes on your personal tax return. You don't have worry about registering with the Secretary of State. To an extent, you don't have to worry about maintaining corporate records or having annual meetings. You sign all contracts in your own name. It is simpler than having a corporation.


Of course, there are downsides to remaining a sole proprietorship (see below).


How do you "form" a sole proprietorship?


There is one step to "forming" a sole proprietorship: start operating a business for profit. That's it.


There are steps you might need to take to operate the business (for example, filing a fictitious business name statement, or obtaining business licenses). However, operating the business is all you need in order to "form" the sole proprietorship.


Are there any pitfalls of using a sole proprietorship instead of a limited liability entity?


Yes. Because there is no limited liability shield, your personal assets are fair game for business creditors.


What happens to your business if you get sued? What about when debts start to accumulate before you start realizing income? What happens if someone slips and falls in your store? What if an employee gets injured on the job? What if you end up with a medical emergency; is that the end of the business?


You're on the hook. If a judgment is entered against you, the creditor can come after your personal assets. They can put a lien on your house. They can levy your personal bank accounts. This is why most attorneys will recommend that you set up an entity that offers a limited liability shield (which I explain here).


There may be a few occupations where it might make sense to remain a sole proprietorship. If your business is fairly low risk, like selling jewelry online, giving guitar lessons, or writing (and selling) poetry.


But even in those largely low risk businesses, beyond a certain point of growth, it is no longer worth the risk of not limiting liability. If you have multiple contracts, an employee or two, substantial income, a storefront, etc., your attorney will probably recommend that you form a limited liability entity.


Conclusion


Sole proprietorships are easy to set up, but they come with serious liability concerns. If your business is something simple and low risk (for example, selling jewelry online), then you're probably fine. But once you start doing contracting work on people's homes, or you open a physical location, or you offer professional services, you should consider forming a limited liability entity instead.

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