Many small business owners apply the KIS principle when launching their new company: Keep It Simple! In their minds, they are imagining that a Sole Proprietorship or Simple Partnership will give them more autonomy in the company’s business dealings, less paperwork and less legal accountability for their business practices than a corporate structure. They may even be thinking that incorporation is something you do once you hit the big time, with multiple locations and hundreds of employees.
Nothing could be further from the truth!
The Pitfalls of Sole Proprietorship
When you operate your business as a DBA (“Doing Business As”), in the eyes of the law, you are your company and your company is you. For example, if your name is Sam Strong, and you are the Sole Proprietor of a small personal training studio called Strong Personal Training, the law sees you as “Sam Strong, doing business as Strong Personal Training.”
Now imagine that one of your studio’s Personal Trainers causes a client to become injured while working on the premises of Strong Personal Training, and imagine that the injured party files a lawsuit. Hopefully you have insurance, which will help. But what if the court awards the injured client a sum that exceeds your insurance coverage? Or alternately, suppose the insurance company uncovers a clause that exempts them from paying in this instance.
In this case, you have no personal protection from a judgement against your business. In addition to going after any and all assets of your business, the courts can come after your car, your home, your life savings and any assets that belong to you or your spouse. In other words, you may be left with no assets and no livelihood. In a worst case scenario, you may even lose your spouse and children to divorce.
What About Partnership?
You may think that having a business partner or partners will mitigate your liability and ease some of the burdens of running a business, but you would be mistaken. Rather than making business ownership easier, a Simple Partnership can complicate matters. For one thing, you have to come to a consensus about everything, from day-to-day operations to how profits are distributed.
Revisiting our scenario, imagine that the Personal Trainer who caused the client’s injury was also your business partner. Even though the incident was not your fault, you will be equally liable for the damages. Perhaps your partner has no assets of his own, while you are more established. Then you can kiss your personal assets goodbye while your partner walks away with minimal responsibility.
Rethinking Your Business Structure
No matter how small or how new your business, it only makes sense to protect yourself from liability for debts or damages incurred by your business. In the eyes of the law, when you incorporate your business, it becomes a separate entity from its owners.
You have some options for incorporating your business, and all have their merits. Many small businesses opt to form a Limited Liability Corporation, or LLC. In this type of structure, you still retain a fair amount of autonomy, but you are shielded from personal liability from creditors or others seeking recovery. Your personal assets are protected in most incidences, because you are not your business.
Benefits of an LLC include:
- Protection of your personal assets
- No business taxes: You report earnings on your personal tax return
- Fewer state-imposed restrictions than other corporate entities
- Flexible management structure with little oversight
- Few restrictions on number of owners
- Greater credibility: Being incorporated instills trust in both clients and potential investors or creditors
Other corporate structures like a C-Corp or an S-Corp may also suit your business, depending on your needs and preferences. The professionals at Windsor Law can guide you in determining the most beneficial corporate structure for your business, and they can walk you through the process to ensure you have met all requirements.