Sole Proprietorship - Is it right for me?

By: Serge Filatov

Many people here in San Jose and Silicon Valley have a dream of starting their own small business. Small business owners that are just starting out often come to me and ask if they can simply run their business as a sole proprietor to save on the cost of forming and maintaining an entity such as a corporation or limited liability company. Although there are some cases where it is fine to conduct business as a sole proprietor, the liability exposure to the business owner individually will likely require a business owner to look at creating a formal entity.

What is a sole proprietorship?

A sole proprietorship is a form of business in which the individual (or a married couple as community property) carries on a business as the exclusive owner and decision-maker.

Benefits of a Sole Proprietorship

There are several benefits to having a sole proprietorship.

First, sole proprietorships have low start-up costs. A sole proprietorship exists simply by an individual carrying on a for-profit business. There are no state registrations required for a sole proprietor simply because they are a sole proprietor (unlike corporations and LLCs). Of course, if a sole proprietor uses a business name other than his or her own name, he or she must register that assumed name (usually a DBA at the county level) although the sole proprietor should also consider whether that name is already in use by another business. Also, certain professions require licensing and the sole proprietor will still need to comply with all licensing requirements for him or her.

Second, sole proprietorships have no annual compliance requirements. Unlike LLCs and corporations which have numerous compliance requirements with the state, a sole proprietorship can simply conduct business without worrying about state compliance requirements.

Third, it is easy to keep track of accounting and prepare taxes for sole proprietorships. There are no accounting requirements for sole proprietorships so one must simply keep adequate records for tax purposes. Additionally, there is no need to prepare a tax return solely for the business because there is no separate entity.

Disadvantages of a Sole Proprietorship

There is one major drawback that comes with the simplicity and cost savings of a sole proprietorship. The drawback is personal liability. Unlike an owner of an LLC or a corporation, a sole proprietor is personally liable for all the debts and obligations of the business. This means that a creditor, to satisfy the debts of the sole proprietorship, can go after all of your assets, including your home. For this reason, and this reason alone, many individuals often choose to form a business entity. Without an entity, an individual leaves himself or herself vulnerable to unnecessary liability.

Another drawback for the sole proprietorship is that it is difficult for third parties to invest in the business. This is because there is no separate entity to invest in; the individual is the business. A further drawback is that since the owner and the business are basically one, it can be difficult to accurately establish financial results for the business separate from the individual owner.

Is a Sole Proprietorship Right for Me?

The answer to this question depends on your specific situation. Generally speaking, if you do not expect to grow the business or have investors, and are conducting a business that has minimal liability risk, you might consider a sole proprietorship. Even if there is some liability risk, obtaining insurance on your business could help minimize risk. However, obtaining insurance is not always easy, is not always affordable, and only provides protection up to the coverage limit and then only for items that the policy doesn’t exclude. Because the answer to this question depends so heavily on the exact circumstances of each person and his or her new business, you should contact a business attorney who can guide you through the decision-making process.

The information appearing in this blog does not constitute legal advice or opinion. Such advice and opinions are provided by the firm only upon engagement. Specific questions relating to this article should be addressed directly to Strategy Law, LLP.

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