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What's Wrong with a Sole Proprietorship?

Posted by Jonathan Krems | Oct 06, 2022 | 0 Comments

In this week's Freedom Friday blog and email newsletter, I want to talk about a topic that comes up with a lot of new clients and even prospective clients who are interested in having the firm help with the contracts for their small business.  One of the first questions I always ask, especially if the prospective client is a new small business, is if they have already formed an LLC for their small business.  Earlier this week I did a consultation for a prospective client, and I wasn't sure if she had formed an LLC or not.  Thank goodness she had formed an LLC, but so many small business owners think they can do business as a sole proprietorship, and maybe for marketing purposes use a DBA.  So, what's wrong with that?  What's wrong with a sole proprietorship?  In today's Freedom Friday blog and email newsletter, I'm going to answer that very question.

First of all, sole proprietorships don't draw a real distinction between the activities of the business and the activities of the owner of the business. While many professionals and service providers succeed because their business promotes the skills and experience of the owner, the obligations and liabilities of a sole proprietorship are also the obligations and liabilities of the owner.

Further, as your small business grows, there is also the possibility of increased risk of liabilities.  These liabilities can include contract debts and also potential lawsuits that arise from the normal course of your business.  For example, if you own a small retail florist, and someone comes into your shop, just a little water on the floor can cause a slip and fall which can lead to a lawsuit against your small business.  Yes, a good general commercial liability insurance policy can help if your small business gets sued for an accident, but if a verdict is rendered against you in excess of your insurance policy, you will personally be on the hook for that excess judgment.

Also, the more successful your small business becomes, the more likely it will be sued.  Unfortunately, if you're not able to get a lawsuit dismissed early on, a jury may find against the sole proprietorship or a general partnership, and these judgments can be against you personally.  A judgment creditor may then try to satisfy the judgment by going after your non-exempt assets.

I mention a general partnership here because many small business owners think they can get some protection by diversifying and bringing in a co-owner to share the load and increase the capacity of the small business.  However, if you decide to turn your sole proprietorship into a general partnership, in which two or more partners agree to operate the business, and share in the profits and losses, you are increasing your exposure to risks and liabilities.  Not only do you have to worry about yourself, but you also have to worry about your partner, because every general partner is both a principal and an agent of the partnership, and is able to bind the partnership, regardless of whether or not the other partner knows what he or she did.  Also, every general partner is personally liable to an unlimited extent for any conduct, act, or omission of any other general partner in the partnership.

So, what is the solution to the pitfalls of a sole proprietorship or a general partnership?  For most small business owners, especially if they are in business by themselves, is to form a single-member limited liability company (LLC).   If you have more than one owner of the business, you can also form a multi-member LLC.  Of course, that's a topic for another day.  But, in a nutshell, what's wrong with a sole proprietorship is that there is no liability protection for the small business owner, and that can be easily fixed.

Thinking about starting a small business?  Or maybe your small business is having issues with contracts, leases, business partners, collection issues, or experiencing other barriers to growth?  Please contact me at [email protected] to schedule a FREE strategy session.

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About the Author

Jonathan Krems

Jonathan is the Founder and Managing Attorney of Liberty Legal Solutions, LLC, a law firm dedicated to building, protecting, and defending the business and personal interests of our clients in Oklahoma.  Jonathan's primary practice areas are business law, contracts and agreements, business liti...


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