So, you’re starting a new business. Congratulations! If you’re like most new business owners, one of your first “executive” decisions will be deciding whether your business should operate as an entity (corporation, limited liability company, etc.) and, if so, which one? First, the bad news. You won’t find the correct answer in a book and neither will your lawyer. Each case is different and your specific circumstances must be evaluated independently to insure that you make the best decision for your particular business.
The good news is that, for the vast majority of new businesses, the decision isn’t that complicated, especially if you involve your attorney and your certified public accountant early in the process. While there may be additional choices, depending on your particular business and where it will be located, your decision will likely come down to one of the following business structures: C corporation, S corporation, limited liability company, or none of the above, in which case you will operate, by default, as either a sole proprietor if you are a single owner or a partnership if there are multiple owners.
Over the next few posts, we will discuss how each of these business structures operates as well as the relative advantages and disadvantages of each. In this post, we will start with the sole proprietorship. If you are a single owner and operate your business without forming an entity, you are a sole proprietorship. This is true even if you use a separate trade name for your business. The primary benefits of a sole proprietorship are simplicity of operation and minimal startup costs. Since there is no entity, there is nothing to file and no filing fees. Likewise, there are no operational agreements and no need to deal with the niceties of your typical business entity like corporate titles, by laws, and documented annual meetings. Finally, since there is no separate entity, there is no separate tax return. The income or loss of your business will be reported on your personal tax return.
The main disadvantage of a sole proprietorship is that you will be personally liable for all the debts of the business. This means that your personal assets will be at risk. In addition, with a few exceptions, proprietorships do not enjoy favorable tax benefits when compared to corporations and limited liability companies. Given the personal liability associated with operating as proprietorship, especially when compared to the relatively small costs involved with forming and maintaining a separate entity, it is rare that you will not be well advised to operate as an entity. However, this is not to say that there may not be circumstances were operating as a proprietorship makes sense, especially where the risk of personal liability can be greatly reduced, for example by obtaining and maintain the appropriate level of liability insurance. And it certainly does not mean, contrary to what you hear on those “incorporate for a $1.00” ads on the radio, that operating as a proprietorship is the equivalent of committing financial suicide.
Again, while it will be rare, there may be cases where operating as a proprietorship will make sense for you. The key is to make sure you understand and appreciate the risks of doing so and, where possible, that you have taken steps to minimize those risks.