A sole proprietorship is the simplest business structure to set up. It can be used by either an individual or a partnership (of two or more people). A sole proprietor also runs no risk of losing their personal fortune in case of bankruptcy, since all business assets are owned by them personally and not separate entity apart from them. However, this simple format carries several hidden drawbacks that most entrepreneurs tend to ignore while choosing this structure.
We have listed some major reasons why you should think twice before registering your business under “sole proprietorship format” says Aron Govil.
- 1) Unlimited Personal Liability:
- 2) Limited Resources:
- 3) No Separate Entity:
- 4) No Tax Benefits:
- 5) Difficult to Raise Capital:
- 1. I am a sole proprietor, what happens if the business fails?
- 2. How would an unincorporated sole proprietorship be treated for tax purposes?
- 3. What is the difference between a sole proprietorship and a general partnership?
1) Unlimited Personal Liability:
Under this format, owners are liable for any financial loss or damage caused by their company or its operations. This means that your personal possessions – house, car, savings etc. – can be seized to repay any business debts.
2) Limited Resources:
A sole proprietor has limited resources at their disposal as the company is not separate from the owner. This can impact the company’s ability to expand, take on new projects or hire employees.
3) No Separate Entity:
In case of a legal dispute, the owner is personally liable and there is no separate entity to protect them. This could lead to costly and time-consuming litigation.
4) No Tax Benefits:
A sole proprietorship offers no tax benefits as it is not a separate legal entity. All profits and losses are reported on the owner’s personal income tax return.
5) Difficult to Raise Capital:
It can be difficult for sole proprietors to raise capital as they are not able to sell their business interest. This is why many small businesses must rely on outside investors or potentially diluting their ownership in order to accomplish growth objectives.
All these factors make it very important for you to think through before choosing your preferred business structure. Your selected format can impact the success of your business, so taking time now will save you a lot of problems later.
There are a few reasons why you should avoid incorporating your business under a sole proprietorship format. First and foremost, when your business is incorporated as a sole proprietorship, you are personally liable for all the debts and obligations of the business. This means that if your business fails, you could lose everything – including your personal assets.
Another reason to avoid incorporating as a sole proprietorship is that it can be difficult to raise capital. Investors are hesitant to put money into businesses that are not structured as corporations, since they are not protected from personal liability in the event of bankruptcy.
Finally, as a sole proprietor, you have less flexibility than a corporation when it comes to hiring employees and managing your business operations. You will be personally liable for all the employment taxes and withholding requirements of your company. This is very risky if you hire employees with no previous business experience, don’t keep track of the time they work, and fail to deposit withholdings in a timely manner.
All this means that incorporating as a sole proprietorship can be hazardous to your personal wealth and may lead to financial ruin. If the sole proprietorship is not incorporated, it will be treated as a separate entity by default. That is because there has been no legal requirement stated on how to form a business in most states until recently when California passed a law requiring some basic filings before forming a Sole Proprietorship or General Partnership (more about this later).
Incorporating as a sole proprietorship can be a very dangerous proposition, and it is highly recommended that you consult with an attorney before making any decisions.
1. I am a sole proprietor, what happens if the business fails?
Under an unincorporated sole proprietorship, you are personally responsible for any losses or debts of your business. If your business cannot pay those debts, those creditors can come after your personal property – such as your car, house and savings – to pay the debt owed by the business.
2. How would an unincorporated sole proprietorship be treated for tax purposes?
For tax purposes – you have only one option – filing a Schedule C with your 1040 tax return that reports all income and expenses of the business on your individual 1040 form. This is how it will be treated until July 2010 when California passed a law requiring some basic filings before forming a Sole Proprietorship or General Partnership.
3. What is the difference between a sole proprietorship and a general partnership?
The main difference between a sole proprietorship and a general partnership is that in a general partnership, the partners are personally liable for the debts of the business. This means that if the business fails, the partners can be sued and may have to pay out of their own pockets to satisfy the debt. A sole proprietor is not personally liable for the debts of the business.
So what’s the moral of this story? If you’re incorporating your new business, it might be a good idea to form an LLC or Corporation instead of a sole proprietorship. According to Aron Govil an LLC or Corporation protects you from personal liability in the event that your business fails. You don’t have to worry about being taken to court by creditors because they cannot come after your personal assets for repayment for any debt owed by the company. However, there are always exceptions to these rules so please contact an attorney before making any decisions.