You like the ease of operation as a sole proprietor. There are no annoying state fees and no bothersome annual meeting requirements. Corporations must follow corporate formalities—and you’re not into formalities of any kind. Doing business as a sole proprietor is easy. You really like easy.
But at the risk of sounding like a parent, is easy really always best?
If your easy-to-operate sole proprietorship is sued, it is easy for the other side to reach all of your assets. A sole proprietor (or “SP”) offers no liability protection, whereas a corporation or LLC shields your personal assets from attacks. For a plaintiff’s attorney—easy does it. They love the unlimited personal liability of an SP and the ease of reaching all of an owner’s assets.
Easy keeps you on the playground. But what if you want to grow beyond those boundaries? You can’t with a sole proprietorship.
Here’s Where it Gets Complicated
There is no selling of an interest in an SP. By definition it is just you. If you sell 5% of the business to a friend, you become a general partnership—which is worse than a sole proprietorship. Now you have unlimited personal liability times two—both you and your new partner are liable for each other’s mistakes. You are much better off becoming a corporation or an LLC to head off that unlimited liability.
But hold on, you say. That wouldn’t be easy. Yes, but how easy will it be to tell your spouse that you lost everything in a lawsuit? We are seeking perspective here.
A sole proprietorship dies with the owner. The business is dissolved upon their death. While the assets can be sold, businesses sell for higher values as a going concern. A corporation or LLC (collectively “a business entity”) has perpetual life. It can be sold independent of the owner as a going concern. It’s easier to sell a business entity than an SP.
Yes, you read that right. Incorporating leads to an easier sale. I know that confuses the easy argument. But as the parent here that is my job.
Let’s go back to the ease of a sole proprietorship. As a matter of fact it is much easier for an SP to be audited by the IRS. Sole proprietorships are audited at a five times greater rate than any other business entity. Which means after your audit it, is much easier to owe more money to the IRS as a sole proprietorship. Is easy always best?
You want to build credibility for your business. Many customers want to see that you are established and for real. The letters “Inc.” or “LLC” after your business name convey a professionalism and seriousness about your services. The use of a corporation or LLC means you understand the risk of business. It says that you have assets and want to protect them, which is an implied indicator that you are successful. In business, success breeds success.
The easy way, the sole proprietorship route, implies a laxity. We all know people who always take the easy way out. They don’t work very hard and they don’t really care. Is that how you want to be perceived in business?
Forming a business entity is neither difficult nor expensive. In fact, and of course you can see this coming: Setting up a corporation or LLC is easy. This checklist from Nav breaks it down.
The credibility of operating through a business entity is also easily gained. Which appears more professional:
Joe Jones, doing business as Aspen Landscape
Aspen Landscape, Inc.
By incorporating and taking the simple step adding “Inc.” behind your business name you have immediately jumped from the playground to the real world. You have joined the ranks of serious entrepreneurs who are serious about their business. And who are serious about protecting their personal assets. It isn’t hard to do.
Establishing Credit as a Sole Proprietor
Finally, it is very important for new and growing businesses to establish business credit. While you may be able to rely on personal monies, personal credit, and personal guarantees when you start out, at some point you will need to access that second track of credit. This is the credit you establish through your business. When your company pays its bills on time it can build up this second line of credit—the business line of credit independent of your personal credit. Credit expert Gerri Detweiler and I wrote about how to benefit from business credit in our book, “Finance Your Own Business.”
Is it easy to establish business credit through your sole proprietorship? No. It is impossible.
As an SP, you personally are the business. So you can use your personal credit, but that will only take you so far. As an SP you aren’t a formal business entity. As such, you can’t build business credit and thus it becomes much harder to access business lines of credit. The SP does not make it easy for you to grow the business.
When we compare things on the easy scale, a formal business entity beats out a sole proprietorship every day. As a corporation or LLC, it is easy to:
- Protect your personal assets
- Sell an interest in the business
- Minimize IRS audits
- Appear credible to customers, and
- Build business credit
By comparison, the sole proprietorship is just easy to set up. After that, everything is difficult. Now you know.