It Might Be Time To Restructure Your Sole Proprietorship

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From Small Business Trends, Nellie Akalp discusses five reasons why someone might want to restructure a sole proprietorship and change it to another business form. Nellie writes:

1. You’re Concerned about Personal Liability

The sole proprietor of a business can be held personally liable for the debts and obligations of the business. Your own personal savings, property, and other assets are at risk to settle any debts of the business. If something should happen and your business is sued or can’t pay a debt, you will probably be required to pay up from your personal savings or property. This is because with a sole proprietorship, there’s no separation between the business and business owner; they’re one in the same.

When you form a corporation or LLC, you are separating the business from the business owner. In many cases, this offers a shield between your personal assets and the business. In industry terms, we refer to this as the “corporate veil.” A corporation (or LLC) exists as its own entity: it’s responsible for paying its bills, meeting its obligations, etc. Whether you’re in a high-risk business (like catering or selling a product to consumers) or a low-risk business (like writing), unexpected things can happen and having a corporate shield can bring peace of mind that your personal assets are protected.

2. You Want an Investor or Loan

If you plan on expanding in the future, either by finding an investor or getting a business loan, then you’ll need to have a formal business structure that’s different than a sole proprietorship. As a sole proprietor, you can only get a personal loan; that’s because there’s no separation between you and the business. Likewise, investors typically won’t invest in a sole proprietorship, as there’s no way to divide ownership or issue shares for the company. In order to receive a business loan or investment, you need to separate the business from your personal finances by setting up a legal business entity such as a corporation (C Corporation or S Corporation) or LLC.

3. You Start Working with Larger Businesses

In the course of growing your business, you may seek out work with a larger company and be surprised that their contract stipulates that you’re operating as a corporation or LLC. This is for a few reasons. First, there’s an assumption (whether it’s correct or not) that an Inc. or LLC is a more stable and trustworthy business partner than a sole proprietor.

In addition, there has been a lot of discussion over the past few years about the IRS cracking down on companies that improperly classify workers as contractors instead of shelling out payroll taxes and other benefits for an employee. If a company hires a sole proprietor for contract work, they may need to show proof to the IRS or state that the worker is indeed independent and should be considered a contractor. Yet, if a business hires an LLC or corporation for the same work, there’s no question about the classification.

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