Considered the simplest business structure, the sole proprietorship is owned and operated by one person, and there’s no legal distinction between the owner and the business. It’s 100% legal for an entrepreneur to operate as a sole proprietor, but that doesn’t necessarily mean you should.
Here are three situations where the sole prop can cause you trouble:
1. You’re concerned about protecting your personal assets
With a sole proprietorship or general partnership, your own personal savings, property, and other assets are at risk to settle any debts of the business. This means that if your business is ever sued or can’t pay its bills, you’ll most likely have to fork over your own personal savings. That’s because there’s no separation between “you” and “your business” with the sole prop.
However, once you form an LLC or a corporation for your business, it exists as its own entity. In most cases, this offers a shield between your personal assets and the business. Having this kind of shield is critical if you work in a “risky” business—such as if you’re a caterer or you’re selling/manufacturing a product for consumers. But in reality, unexpected things can happen in any industry. For example, a copywriter could be sued by a client for unintentional plagiarism.
2. You eventually want to find investors or partners for your business
If you have any plans to expand in the future—whether that’s by finding some investors, taking on a partner, or getting a business loan—you’ll need to have a formal business structure other than a sole proprietorship. That’s because as a sole prop, it’s just you. There’s no room for anyone else in the business.
3. You want to do business with larger companies
Larger companies typically prefer to do business with corporations or LLCs, not sole proprietors, for several reasons. First, there’s peace of mind that comes with doing business with an established LLC or corporation. As a sole proprietor, you may be the most dependable, long-term partner a business could ever hope to find. However, some people just assume that an Inc. or LLC is more legitimate and trustworthy than a sole proprietor.
Beyond these matters of perception, there can be significant tax implications when a corporation hires a sole proprietor as a contractor. That’s because the IRS could determine that they’ve improperly classified the worker and should be treating them like a full-time employee (and paying payroll taxes) instead of a contractor. That isn’t a concern when hiring an LLC or corporation.
In addition to these three reasons, you may have added incentive to drop the sole proprietorship in favor of an LLC or corporation. And, that’s because when you’re an LLC or Corporation, you can structure your business in such a way to reduce what you have to pay in self-employment taxes.
Not ready to create a formal business structure yet?
Not everyone is going to be ready to incorporate or form an LLC for their business, and that’s okay. You can run a legit business even before you form an LLC or incorporate. In this case, you’ll need to file a DBA (Doing Business As) in order to register your business name with the state. This act lets the public know who’s the owner behind a business. It also allows you to open a bank account under your business name and prevents anyone else from using the same business name in your state.
While most small business owners I know have little time to spare, I encourage you to take some time to investigate all the various business structures. You can even speak with a tax advisor to learn more about your own personal situation and how you can lower your self-employment tax and minimize your personal liability. Your business will thank you.
This was originally written by Nellie Akalp for The Mogul Mom