The Danger of Being a Sole Proprietor! Why You Must Form the Proper Business Entity for Your Business.

May 12, 2023

Starting your own business is exciting and freeing. You are now your own boss, you can work at your own pace and create the products and services that you want. However, it also involves a lot of careful decisions. One involves choosing the right business designation. When starting your own business, if you plan to be self-employed your main choices are sole proprietorship or limited liability corporation (LLC).

You may look at sole proprietor as a business designation as an obvious choice. You are the proprietor of your business, and you work independently. Why make it complicated? But sole proprietorship may not offer you all of the protection you need. This is especially problematic when it comes to business liability.

The Problem With Sole Proprietorship

A sole proprietor is not a legal entity separate from the business owner. An LLC is. A sole proprietor is responsible for all of the assets and debts of the business. If debt collectors come for your business, you are the one who has to pay. If someone files a complaint because of something that happened with your business, it’s you who gets sued, not your business. There’s no safety net, which can lead to a plethora of issues for self-employed workers. In some cases, it can run you out of business, even if you have insurance.

Let’s get into an example:

Sole Proprietorship Horror Story: The Landscaper and the Flood

This story of a sole proprietorship gone wrong comes from CPA Diane Kennedy of US Tax Aid, about a landscaper who ran into trouble when his customer’s home flooded. Although many places in the area flooded and the landscaper was likely not at fault, the homeowner sued the landscaper for $1.4 million and won.

The landscaper, who was a sole proprietor, was insured and their insurance covered the brunt of the cost: $1 million. However, that left $400,000 that was the landscaper’s responsibility to pay. For a business entity, $400,000 is already a significant number. For an individual, it’s overwhelming. In this case, it was more than the landscaper had. They lost their business, their savings, their home, and the funds set up for their children’s college.

An LLC would not protect from all responsibility. There still would have been a lawsuit, and distinctions like sole proprietor or LLC would not change the jury’s verdict. However, with an LLC, only the landscaper’s business would be liable. They could lose their business, but their personal assets would remain untouched.

Critical Related Business Documents

It is critical to have a customized and carefully crafted operating agreement for your limited liability company. There are similar documents needed if you choose to form a different type of business entity. Additionally, you may need employee agreements, IP assignments, etc. The Garcia-Zamor team can make sure that all of the proper legal documents are prepared to give your business the best probability of success.

The Moral of the Story

Unfortunately, this is all too common with sole proprietors. They land themselves in debt or they’re sued, perhaps by a past customer, and they end up losing far more than their business. At the end of the day, you can recover from the loss of a business. It can be much harder to recover from the loss of your personal assets.

The good news is that an LLC can be readily prepared by the Garcia-Zamor attorneys. You can even switch from a sole proprietor to an LLC to be better protected in the future. The attorneys at Garcia-Zamor advise and guide you through the process and take care of forming your limited liability company.

With over two decades of experience, Garcia-Zamor is here for you and your self-employed business. Contact us today to learn more about how we can help you protect yourself from business liability.