Avoiding The Crosshairs of Sole Proprietorships

Every business has a story. The beginning of their story is
often humble with nothing but a novel idea and a steely determination. Sitting
in a garage, spare bedroom, or booth of a diner an entrepreneur may create the
next Apple, Google, or Amazon for the world. That is the American Dream; to
create something truly from the “ground up.” 
Initially most of these businesses operate as a sole proprietorship,
meaning that there is no distinction between the business owner and the
business itself.  This seems like a logical choice, as many business
owners, especially those in specialized or technical areas, market their
personal reputation and skills to grow their business. However, problems arise
when that business evolves from a part-time home-based hobby to a growing and
profitable venture.
You started a business to build something for yourself, to
be independent, and let your success be determined by your skills and
determination, while doing something you love to do. Most business people want
to build an enterprise that someday will outgrow them. At some point, it is
normal for a business to transition away from the owner working in the
trenches, to hiring young guns or bringing in business partners to take the
company to the next level.
So, why should a business owner
transition from a very comfortable sole proprietorship to a more formal legal
entity, such as a corporation or limited liability company? The answer, is the
same as why your business is a success in the first place. It is because of
you. Sole proprietorships do not draw a practical distinction between the
activities of the business and its owner. So, while many professionals and
service providers are successful because their business promotes the owner’s
skill and expertise, the obligations and liabilities of a sole proprietorship
are also the liabilities and obligations of the business owner.

When your business is large enough
to hire employees or look for additional capital or skill sets through
employees, partners, or investors the rationale for a sole proprietorship or a
general partnership are typically long gone.

With the increased expansion of the
business comes the increased risk of liability. Liabilities may include
contract debts and potential lawsuits you may face as a result of something
that happens in the normal course of your business. It is axiomatic that the
more successful your business becomes, the greater the likelihood you will be
sued. Unfortunately, if you are unable to dismiss a lawsuit early in the
litigation process, there is a chance that a jury may find against the sole
proprietorship or a general partnership, which is essentially a judgment
against you.  A plaintiff may then try to
satisfy the judgment by going after your non-exempt personal assets. 

Sometimes, a business will diversify
by bringing in partners, but not transitioning to a legal entity, with the hope
that a co-owner will share some of the business and financial load.  If you decide to make the sole proprietorship
a general partnership – where two or more partners agree to operate the
business, and share in the profits and losses – you have essentially “doubled
down” on your exposure.  Not only do you
have to worry about yourself but, in a general partnership, you also have to
worry about your business partners and their conduct because every general
partner is both a principal and an agent of his or her partnership, and is able
to bind the partnership to obligations, regardless of whether the other
partners know about it or not.  Every
general partner is personally liable to an unlimited
for any conduct (act) or omission of any other general partner.

The only downside to setting up a
separate stand-alone legal entity is the slightly more formal requirement of
the operating business entity. Yes, you have to file separate tax return, and
yes, you should consult with business attorneys, at least on a quarterly basis,
to ensure company documents are periodically updated and that the company is
operating and functioning appropriately.

Business and corporate attorneys, such as the attorneys at The VethanLaw Firm, P.C., routinely assist businesses and business people with issues
regarding corporate governance, employment law matters, and assist in
implementing policies to protect its intellectual property rights. Our
attorneys are experienced and enjoy working with business people. We look
forward to working with you and your management team to address your business
and corporate concerns.