“Ask the Business Attorney”: What’s Wrong with a Sole Proprietorship?

by Scott Edward Walker on June 23rd, 2010


This post was originally part of my “Ask the Attorney” series which I am writing for VentureBeat (one of the most popular websites for entrepreneurs); it is part 2 of 3 of my posts on choice of entity.  Last week (in part 1), I discussed what’s wrong with an LLC.  This week I address what’s wrong with a sole proprietorship; and next week I’ll address what’s wrong with a partnership.  Please shoot me any questions you may have in the comments section.  Many thanks, Scott


I founded a web company by myself a while ago and for the last six months I’ve been making some serious coin.  I never formed a corporation or an LLC and was wondering  if you think I should.  I’m not looking for VC funding, and all the guys who work for me are independent contractors.  Why can’t I just remain a sole proprietorship – seems like a waste of money to incorporate at this point.


The short answer is that a sole proprietorship is great until you get sued.  Indeed, I’m not a big fan of sole proprietorships — and not many good corporate lawyers are.

The advantages of a sole proprietorship are pretty obvious.  First, it’s simple.  There are no legal documents that need to be drafted and no filings with governmental entities (other than perhaps a simple fictitious name or “DBA” certificate if you are doing business under a name other than your own).

Second, it’s inexpensive for the reasons noted above – that is, no legal documents and no filings means no legal fees and no filing costs; and third, there is no “double taxation” – meaning, unlike with a C corporation, the business does not pay income taxes separately.  All income taxes are handled on the owner’s personal tax returns.

As noted above, the biggest disadvantage with a sole proprietorship is that you have unlimited personal liability.  In other words, you as the owner will be held personally liable for all of the business’s activities, including its debts and liabilities.  Why?  Because for legal purposes, there is no distinction between the business and the sole proprietor.

With a web business, there may not be a lot of potential liability exposure compared to, for example, a medical device company or a real estate owner; however, there could be lawsuits relative to IP infringement, privacy regulations, your contractors (in certain circumstances) and other issues.  And if you do get sued, that would mean all of your personal assets (money, home, car, etc.) would be at risk.

Another major disadvantage of a sole proprietorship is that you cannot issue equity (whether it be to a key employee or an investor) because, again, a sole proprietorship is not a separate legal entity.

Finally, there is arguably greater tax audit risk running a business as a sole proprietorship and, accordingly, reflecting the business’s profit or loss on the Schedule C of your federal income tax returns.


The bottom line is that sole proprietorships have limited utility for entrepreneurs and should generally be avoided due to the unlimited personal liability and lack of structure for equity issuances.  Nevertheless, if you still insist on remaining a sole proprietor, you should definitely buy some comprehensive liability insurance from a reputable insurer to protect against lawsuits and other claims.

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