Frequently, budding entrepreneurs merely evolve into business without giving it the upfront thought the transition deserves. They become what are usually known as “sole proprietors” operating “sole proprietorships,” or one-man/woman businesses.
A sole proprietorship is the simplest form of business organization and can be formed merely by beginning business, though some form of business license, tax registration, and/or a “DBA” (“doing business as”) filing is usually required. If the business is to have employees, a separate tax employer identification number (EIN) is also required. Simple and relatively easy to get started, and, for that reason, the majority of small businesses in the United States are “sole proprietorships.”
Simple, in large part, because the business is not legally separate from its owner; the business and the owner are legally considered one and the same. Because of this characteristic, there are some distinct advantages to this form of business. There is no “double taxation” as there may be with some corporate structures because sole proprietorship income and expenses are reported on the tax return of the owner as his/her business income and expenses, though the owner must pay self-employment tax. Management and control issues are relatively simple because the owner is usually the manager. The business can have whatever duration the owner chooses and can be sold at will.
One very significant disadvantage of the sole proprietorship, however, is the unlimited personal liability of the owner not only for his/her own actions in operating the business, but also for those of his/her employees as well. Before other forms of business organizations evolved into the structures that exist today, the advantages of sole proprietorships could outweigh this very significant disadvantage, particularly where the risks of being sued were relatively small and where insurance could be purchased to obtain some protection.
However, because business entity structures have significantly evolved over the last few decades so as to provide essentially the same advantages as sole proprietorships, but also the protection of limited liability in a world where law suits seem to be the rule rather than the exception, we believe it wise for every person thinking of forming a business to think carefully about what legal structure might serve best. We believe that it is important for other good business reasons as well, such as having a structure that will facilitate raising the necessary capital to grow while retaining control and providing for different levels and types of returns.
One size truly does not fit all. Early and relatively inexpensive legal counsel can get the budding entrepreneur started off right, significantly reduce potential liability and increase value for the future.
Tarley Robinson, PLC, Attorneys and Counsellors at Law
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