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  • Writer's pictureDavid Manes

Acting as a sole proprietorship has hidden costs for startups

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When you start your own business without creating a separate legal entity, you are considered a sole proprietorship. A sole proprietorship is the most basic of legal business forms and many businesses operate as one without even knowing it. There are a few benefits to doing business as a sole proprietorship such as not having to spend the money or time to file, but the risks of operating as one usually outweigh the benefits. This article is about the hidden downsides to running your business as a sole proprietorship.

Unincorporated businesses have unlimited liability

The sole proprietor (owner of the sole proprietorship) can be held personally liable for the debts and obligations of the business. Thus, if you get sued and your business does not have enough money to pay for the judgment the rest of the cost will come out of your personal money and assets. Forming a company allows you to insulate your family’s assets from anything that might go wrong with the business.

Sole proprietors have limited ability to raise capital

Because of the inherent risk of a sole proprietorship it is difficult to find investors and obtain loans. In order to qualify for most business loans, a business must file as a business entity with the state. Venture capital investors usually require an equity position in exchange for their investment, and that can only be accomplished if you have formed a legal company in the right way.

Sole proprietorships have no continuity

The business does not continue if the sole proprietor becomes deceased or incapacitated. Upon the sole proprietor’s death the business is liquidated and becomes part of the sole proprietor’s personal estate. The proceeds from the liquidation are then distributed to the beneficiaries and this can result in heavy tax consequences to the beneficiaries.

Resist the urge to cut corners with incorporation

All of the above dangers can be avoided by choosing to file paperwork with the state and giving your business a legal entity such as a Limited Liability Company (LLC), an S Corporation or a Limited Liability Partnership (LLP). These are just a few of the legal forms that can protect your business and help keep your money and assets safe. For more information regarding the right business form for your company contact an attorney or do some research on your own.

Guest post by Joseph Pometto, J.D.

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