One of the first decisions every entrepreneur must make is under what business form to operate the venture. Those who do not make this decision allow the state to make it for them.
There are five major business forms from which to choose: the sole proprietorship, the general partnership, the corporation—both S and C—the limited liability company, and the limited partnership. The easiest to form are the sole proprietorship and the general partnership, but the ease of formation comes at a potentially great cost: unlimited personal liability. These forms should therefore be avoided. If you own a business and are unsure under what business form you operate, you likely operate under one of these two undesirable business forms.
The Sole Proprietorship
A sole proprietorship is a business owned and operated by a single individual, there being no legal distinction between the owner and the business. The debts and obligations of the business are also that of the owner, and so the owner’s assets are available to creditors seeking to satisfy the debts of the business.
The lack of distinction also opens the business owner to personal liability for any legal judgments against the business. A customer that slips and falls in the business’s parking lot may file suit against the business owner personally, thereby exposing the owner’s home, car, and personal bank accounts to potential seizure to satisfy a court judgment.
The danger of unlimited liability becomes particularly poignant in light of the fact that the law holds a business liable for the acts of its employees. So an employee’s injuring someone at work may result in the sole proprietor’s losing his or her home. While this may seem inherently unfair, these are the risks one faces when operating as a sole proprietor.
The General Partnership
A general partnership exists where two or more individuals, who have not selected another business form, conduct an enterprise together for the purpose of securing profit. Like a sole proprietorship, a general partnership subjects the owners to personal liability for all of the debts and obligations of the business.
As an added risk, however, each partner is also personally liable for the actions of the other partners. So, for example, if one partner incurs a large debt on behalf of the business, all the other partners are personally liable for that debt, even if the responsible partner abandons the business.
The dangers of these business forms make them undesirable in almost all circumstances. Business owners should consider operating as either a corporation or limited liability company to protect themselves from unnecessary risk.