Technically, nobody needs a formal business entity; a business can run as a sole proprietorship or a general partnership, both of which require very few formalities. But in the long run, that’s not always the brightest decision for your brand. There are a couple of things to consider! But first, let’s breakdown sole proprietorships and general partnerships a bit more.
Sole Proprietorships and General Partnerships
Sole proprietorships (flying solo; one person only) and general partnerships (teamwork; more than one person) initially seem appealing to a lot of business owners. They have a “pass-through” tax structure, they’re flexible in their organization, they require no setup fees (other than whatever you might want to pay to an attorney to assist you), and are formed without any paperwork. In fact, most people inadvertently form these kinds of businesses and don’t even realize it; you might already be part of one! All it takes is the intent to act as a business for profit, a wink and a nod. Okay, so actually the wink and nod are optional….
BUT, there are some downsides to General Partnerships and Sole Proprietorships.
The Big Issue of Unlimited Liability
The biggest issue to consider is unlimited liability. As a sole proprietor or a general partner, your assets and the business’s assets are indistinguishable. What does that mean? It means if someone at your business slips and falls, or is injured using your products, not only will your business be on the hook for any potential judgment against you, you personally will be on the hook as well.
Forming a general partnership can make this even more risky because you can also be held responsible for the actions of your partners. So if your partner goes rogue and ends up costing your business more than it can pay for, your house, your car, and maybe even your firstborn child are on the line. Basically any risk taken in a sole proprietorship or general partnership can affect your personal assets.
Have Hope! There’s Good News!
We were only joking about the firstborn child thing! More good news: you can limit your liability if you form the right kind of entity. As the name would suggest, an LLC, or Limited Liability Company, offers a “liability shield” for your personal assets; a corporation works similarly. Under either of these entities, as long as you observe the required corporate formalities (recording decisions, keeping separate bank accounts, treating this entity as separate from you, etc.), even if someone slips and falls at your business, you can’t be held personally liable for any judgment against the business. This means that you, and any other members or investors you convince to join you, can only lose whatever you have put into the business.
Advantages of LLCs and Corporations
There are other advantages to LLCs and corporations. Here are a few:
- In a general partnership, any partner’s withdrawal from the partnership for any reason triggers a dissolution of the company; this is not an issue with LLCs and corporations. They can survive just about any change, unless the governing documents say otherwise.
- Another advantage you’ll likely enjoy by forming an LLC or corporation is ease of outside funding. If you need to raise outside capital, creating an LLC or corporation gives investors a sense of security that they wouldn’t have with an unlimited liability operation like a general partnership or sole proprietorship. You can also sell shares of an LLC or corporation, which allows for easier and more predictable ownership tracking.
- Pass-through taxation is not limited to general partnerships; LLCs can also utilize this tax structure, which can be useful to some business owners.
LLCs and Corporations aren’t one-size-fits-all, but generally the limitation on liability makes them better for most businesses than general partnerships or sole proprietorships. To get an idea of which entity would work best for you, explore our other resources below! And, as always, feel free to reach out to us with any questions.
By: Olivia Phillips – 10/20/17
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