5 Reasons Your Business Should NOT Be a Sole Proprietorship

Episode 79 on the Business Bites Podcast

The Gist Of This Episode:  You want to quickly get your business up off the ground and/or you’re overwhelmed with the legal side so you simply file nothing.  The unfortunate aspect is that this can hurt you greatly – not just professionally, but personally.  This episode will walk you through the five reasons why you need to get an LLC or a Corporation. 

What you will learn:

  • Basics of sole proprietorship
  • What separate bucket liability protection is
  • How having no assets is not a good reason to say you are going to be an SP
  • and more!

Expand To Read Episode Transcripts

Hey guys, welcome to the Business Bites Podcast. I am your host Rachel Brenke, and we’re going to dig in, talking today about one of the most common questions that I’m seeing in Facebook groups, they’re coming into my inbox, chat, you name it guys. I’ve talked extensively in the past about business formation and how to protect yourself, because we’re in business, but that doesn’t mean that we want to lose our personal life. I’m not just talking from a time perspective. I’m talking from an asset and financial perspective. We’re putting ourselves out there, we’re sharing our brand, we’re sharing out stories, we’re putting our money into this business, and we want to make sure that we’re personally going to be protected.

I have other episodes that I’m going to link in the show notes that you guys can check out, and it’s going to have episodes like, the Different Business Types for Entrepreneurs, How to Set Up an LLC, et cetera. But this episode, I want to very specifically talk about five reasons that I think you guys should not be a sole proprietor. Now keep in mind, I know that I have some people that are overseas. This is a United States based podcast, so a lot of the legal information that I talk about here is US based.

If you are US based, my little CYA for this is that this is general information, please always seek the advisement of your local business attorney. You’re welcome to reach out through Rachel Brenke on Facebook, Twitter, Instagram, all those places, or you can dive into the Business Bites Facebook group, and you guys can ask questions and I can help you find a local attorney from there. If you don’t want to do all that, just check out the local Chamber of Commerce or other recommendations in your area. But please always make sure you don’t just blindly take my advice, although I think you’re going to find that business lawyers out there are also going to recommend what I’m going to say in this episode.

This is episode 79. You guys are going to be able to find the show notes at RachelBrenke.com/epi79. You can find the podcast anywhere, Apple, Spotify, SoundCloud, Google Play. Please, if you enjoy the podcast, if you would like to support me, and I hope you do if you’re listening, please leave a five-star review and some feedback. It really does help me to be able to continue doing this for you guys, especially free of advertisements and without having to muddy up the waters with financial making things, I able to provide this resource freely to you.

All right, let’s go ahead and dig into five reasons to not be a sole proprietorship. As you guys will have probably already understood or have seen through my other episodes, there are different types of business formation in the United States. Sole proprietorship is the default structure, and many times you guys are just starting out. You’re either part-time, or you just have an uncertainty as to whether you’re going to make it business. Many times you don’t take the steps to file to become what’s called an LLC or a limited liability company, or a corporation, just because you’re like, “Oh, I’m not making enough,” or simply, “I don’t even know if I’m going to be able to hack it.”

But the thing is, many of you may be sitting on a dangerous risk. With sole proprietorship guys, there’s no protection available for you. Now yes, as I talk about in other episodes, you can also have liability insurance that can help you out, but that’s not foolproof. You should always have layers of protection. Little spoiler before you guys get to those episodes, which again will be linked at the show notes, but the layers you want to have are your business formation. Obviously by the title of this episode, you should not be a sole proprietorship. You need to look at either LLC or corporation to protect your assets. You want to have liability insurance, and then you also want to have the proper contracts and legal documents in place.

Yes, there are specific times and places for sole proprietorship businesses. You guys are correct with that. However, I don’t feel comfortable recommending this formation because it’s so risky, even when you have ironclad contracts and insurance. I want you guys to understand through this episode, that I also get that not many of you have the money or knowhow to become an LLC or a corporation. But I want to encourage you to have the understanding of the risk of being a sole proprietor so you can specifically make a game plan to grow out of that sole proprietor formation, and become an LLC or a corporation.

What is a sole proprietorship? I’ve kind of already given it away. Colloquially, it’s having all your business and personal assets thrown into the same bucket. There’s not a separation between the two and there’s no liability protection arising out of the formation. It’s a streamline process. Like I mentioned before, being a sole proprietor is the default structure. Many times you guys are creating a sole proprietorship without realizing. It’s the default formation that occurs when you’re in business, whether you’re full-time, part time or just acting like it on any timeline.

Now, state laws do vary on formation requirements. Some do require, if you’re having a different trade name, you have to file what’s called a fictitious name or DBA et cetera. However, that does not keep you from being a business. If you’re acting like a business, you’re putting yourself out there, you’ve default created a sole proprietorship, and there’s no division between you personally and your business.

Let’s jump into first, the liability risks. Obviously, while sole proprietorship is probably the easiest and cheapest formation, it also brings with it very little benefits. Sure, you’re a formed business. You may have ease of filing taxes as they’re done for federal income tax on your same income tax return as your personal. But there’s an uphill battle of trying to take your personal assets out of that bucket when an issue arises. Such as, when you form an LLC or corporation, we don’t have just a single bucket anymore like a sole proprietor. We have two buckets. Now you have an LLC or a corporation bucket that holds your business assets, and you have a different bucket that is your personal stuff.

Just keep in mind that whereas of now, as a sole proprietor, your assets are not separated and if anybody comes after you. Here’s the thing guys, it’s not if it’s going to happen, it’s going to be when. Somethings going to happen down the line. I’m not saying that you’re purposely doing it. I’m not saying that people are all crazy, some are, but you guys, it’s going to happen at some point. It also depends on what type of business that you’re in. Maybe you’re in a really high risk business. Well, obviously then you really need to make sure that your personal assets are separate from your business assets. But it doesn’t matter if you just have a simple ecommerce site, or you’re doing one on one services, or whatever it is that you’re offering, you want to try to make sure that everything is separated as much as possible.

One of the biggest push backs I always get from people when I talk about these, having assets in different buckets, is you all will say, “Well, I don’t have any personal assets.” To which I respond and go, “Are you breathing?” “Yes.” “Do you have moneymaking capabilities?” “Yes.” Guys, you making money is an asset. It doesn’t have to be, well, I don’t have a house, I don’t have a car, I don’t have X, Y and Z. I rent all that, or I’m living with my mom, whatever it is. Say hi to mom for me. But guys, if you have income earning potential, you have an asset that’s on the line. Just remember that you want to make sure that you are separating out these buckets. An LLC, out of the two options, between LLC and corporation, LLC is the cheapest and easiest. It’s kind of a nice little middle ground, but always refer back to what your local business lawyer says.

Second reason that you should not be a sole proprietor is, it’s harder to access capital. If you reach a point in business where you need to acquire financing, whether through loans or other individuals, sole proprietorships can have a difficult burden of demonstrating the value of the investment. It’s just the reality. You may be someone whose been a sole proprietor for 20, 30 years and have a good track record, but many of us are not. You just need to keep in mind that you want to ensure that you’re setting yourself up in case you ever need to tap into any capital.

A third reason to not be a sole proprietorship is business termination. Should you become incapacitated or deceased, the business ceases to exist as well. A sole proprietorship is tied directly to you and it’s not a passable entity. Whereas if you have an LLC or corporation, and especially if your family is depending upon this money, right? Let’s say you have an ecommerce shop, but it’s set up as a sole proprietorship, and then you decide … Well, maybe you decide to retire, A, I didn’t even mention that as a business termination option. I was thinking more involuntarily, just like with incapacitation or death. But let’s say you decide to retire, or you’re in a car accident and you’re hurt, or you pass on. You cannot pass on the business. You can, but the entity itself does not pass on, and just becomes a bit more complicated. Whereas everything’s in that LLC bucket, it can easily be passed on to somebody else.

A fourth reason not to be a sole proprietorship is personal bankruptcy or credit risks. Unlike other formations, all of your business credit goes under you as an individual when you’re a sole proprietorship. When a sole proprietorship “goes under,” and needs to file bankruptcy, it has to be done with personal assets as well, not just simply business assets. Because remember, there’s no separate bucket protection here. Further, should a business expense fall into collections, a creditor can collect judgment from the bucket that includes personal assets. That goes back to what we talked about before, there’s no separate bucket liability protection. What happens is somebody comes after you and has a claim against you, and they win, they will be touching your personal stuff as well. That judgment can attach to you personally, and that also occurs when it comes with bankruptcy.

Last reason, which there’s more, but I’m just going to give you guys the quick five in today’s quick episode, is that you lose tax benefits. When you’re an LLC with a corporation election, or you’re a formed corporation, there’s tax benefits that can help the business and you. It helps you to save money paid on taxed. Sole proprietors do not receive the same tax benefits that incorporated businesses do and you may end up spending more money than really is needed, bottom line. I’m not a CPA, so obviously you guys need to reach out to get some more information on that. Tax codes change all time, but just understand relatively, sole proprietorships they, “are a business,” but you don’t necessarily always receive the same benefits that other legal entities will, which could ultimately cost you money.

As you guys can see, sole proprietorships may have a place in your business timeline, such as when you’re first starting out and you’re saving up money, but it should only be for a limited period of time. It is best to seek out the LLC or corporation options, and get that done as soon as possible in your business, so that you’re able to make sure that you’re personally protected and you’re just setting yourself up for best business success.

Now again, this is episode 79, so RachelBrenke.com/epi79. I’m going to link a lot of these resource and I’m also going to link some information for you guys to have, so you can reach out to read about it, and see what you can do to get yourself set up. Please make sure you also jump into the Facebook group. It’s just Business Bites Podcast, is the name. We’ll also link it on the show notes page. I look forward to hearing from you guys. Please get out of those sole proprietorship bucket. Let’s multiply that into multiple buckets, protect your business, do the right thing and make sure that you’re set up for success.

About the author

Rachel Brenke is a lawyer, author and business consultant. She is currently helping professionals all over the world initiate, strategize and implement strategic business and marketing plans through various mediums of consulting resources and legal direction.

Hi, I’m Rachel Brenke

Rachel Brenke

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