4 Reasons You Should NOT Operate Your Business as a Sole Proprietorship

By Alex Day

Today I want to get down to some very basic concepts.  I want to cover why you should never run your business as a sole proprietorship.  First let’s cover the difference between a business that is operated as a sole proprietorship and one that is operated as an LLC (our preferred method of establishing a legal entity for a business).  A sole proprietorship is when you have a business and you run it in your name.  There is no legal difference between you and your business.  Any debt you incur is personal debt and you are directly and personally responsible for it.  Any liabilities you incur, whether financial or legal, you are responsible for them.  There is no legal distinction between you and your business. 

When you establish and LLC for your entity (or incorporate as an S Corp or C-Corp), you are establishing a new legal entity for the business.  This legal entity has rights and responsibilities that are separate and individual from you as an individual.  So below are four reasons why we recommend establishing an LLC and running your business as an LLC:

1. Reduction of personal liability

As my attorney and good friend likes to say, this is America, you can be sued for anything.  I have experienced that with one of my companies and I was dumbfounded at what a disregard the legal system has "truth" or "justice".  The LLC through which I was working was sued by an individual who had NO GROUNDS for a case.  The business was insolvent, he was a contractor who had been paid over $25,000 for 3 months of part time work (which he did not meet HIS obligations under the contract) and he sued the LLC.  If I had not had the LLC, he could have gone after me personally.  Have your LLC and be prepared for these type of issues. 

2. Exit

If you have an LLC you have a documented asset which can be legally sold.  You will have records with which you can demonstrate the assets and operations of the business.  I recently worked with a gentleman who had a very nice little business that had a very nice cash flow with virtually no overhead.  I was engaged to help sell the business and I really thought it would be a no brainer.  One of the major downsides that we had was that the business was a sole proprietorship and he had no documentation separate from his personal finances to show what the business was doing.  This became a major issue and we were unable to sell the business in the time period we were provided.  Even if right you think you would "never" sell your business, or that you don't have a business that could be sold, remember that simply having a business operated and documented has some value that you may want to extract at some point in the future.  So, even if you have a business that is tied heavily to your personal skill set, a time in the future could present itself where you could extract value by having the proper legal structure.

3. Taxes

There are significant tax benefits to operating a business.  Remember the IRS now has to look at this entity as a separate legal entity.  There are significant tax benefits you can get from having an LLC.

4. Establishing Business Credit

Banks and lending entities view business credit differently from personal credit.  As a sole proprietorship you are always relying on your personal credit and are blocked from a lot of different lending products.  When you have a legal entity (with a bank account- this is REALLY important), you can establish commercial credit which gives you more flexibility.  Remember that lending agencies view any business that is less than two years old as a startup.  So, get your LLC established as early as possible to get that clock ticking.  Also, remember that initially you will have to sign personally, even with a business line of credit, but as the business becomes established and demonstrates its ability to generate profit, you will be able to get business credit without signing personally. 

These are just some of the reasons that you should NOT operate your business as a sole proprietorship.  Remember that there are costs associated with maintaining an LLC (filing your taxes, maintaining the books, etc.).  But it is my experience that the benefits far out weight these costs.