What are the Disadvantages of a Sole Proprietorship?

Many businesses get their start as sole proprietorships, and some even stay with that structure until the end of the business. Sole proprietorships have many advantages: they are quick and easy to set up, they do not require large amounts of money, and accounting is simple. However, sole proprietorships have many disadvantages as well.

A Sole Proprietor's Personal Assets are Her Business Assets

The biggest disadvantage of a sole proprietorship is that there is no separation between business assets and personal assets. This means that if anyone sues the business for any reason, they can take away the business owner's cash, car, or even their home. In a corporate business structure, there is strict separation between business assets and personal assets, so that when someone sues the business, they most that person can get are the business assets, which protects the business owners.

Most businesses buy insurance in case they are sued. While insurance can help by providing money to settle law suits, it will not always provide full protection. Many policies only cover certain kinds of lawsuits, such as personal injury suits, in case someone slips and falls on your property. Any other suit, like a collection action from one of your vendors, leaves you on your own. Additionally, the money the policy provides may not be enough to cover your damages, which leaves your opponents free to go after your personal assets.

The Business Dies With Its Owner

Courts do not see any difference between a sole proprietorship and its owner. So when the owner passes away, the business ends as well unless the owner made a prudent estate plan which allowed the business to continue.

In a corporation, the business is said to have "perpetual existence," which means that the business will continue until its owners, directors, and shareholders decide to end it.

Sole Proprietorships Have Fewer Ways to Raise Money

Corporations have many ways to raise money to invest in the business. One of the easiest ways for a corporation to raise money is to sell more shares -- give people partial ownership of the company in exchange for money that can then be used to grow the business. However, a sole proprietorship has no shareholders and cannot sell ownership in the company without changing its business structure.

Sole proprietorships may borrow money just like other business structures. However, because there is no separation between business and personal assets, many sole proprietors need to use their personal assets as collateral of the loan. Some people even use their home as collateral. This means that if the business fails, and the owner does not have enough money to pay the loan, the lender can take away the owner's personal assets to get their money back.

See FindLaw's small business section to help you decide which business structure is best for you, as well as a useful checklist for setting up a small proprietorship.

Have a Free Initial Legal Discussion

Although sole proprietorships are by far the easiest type of business structure to set up, they also present many vulnerabilities to the owner, including liability for debt. If you have any questions about the legal implications of a sole proprietorship, a lawyer may be able to help. Contact a local attorney for a free initial legal review of your situation to discuss you future business's needs and learn how they can help you plan for success.

Next Steps

Contact a qualified business organizations attorney to help you choose the best formation for your business.

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