Should A Solo Entrepreneur Form A Business Entity?
Anytime someone approaches me about business formation and the business has multiple owners, I always advise that they should form a business entity. The question of which entity to form is far more complicated, but that they should form one is a no-brainer.
If multiple people are operating a business, they are considered a general partnership and have no limited liability. Each partner is liable for the other partner’s actions. The perils of operating a business this way could be its own season of American Horror Story. It’s a total nightmare.
But for a solo entrepreneur, the question is a little more nuanced. The person still doesn’t have limited liability but is only liable for her own actions and not those of another person. So the question about whether a solo entrepreneur should form a business entity comes down to what kinds of liability the person can be exposed to through her business dealings and whether that merits creating a formal business entity.
To be clear, these are simply a few factors solo entrepreneurs should consider when deciding whether to form an entity. Legal advice regarding any specific situation should be directed to an attorney.
(1) Do you have employees? The presence of employees raises the bar on the ways the business can be exposed to liability. Not only do you need protection from your employees’ actions which could expose you to liability, but you also need protection from suits your employees may bring against the company.
(2) Do you make a product? If you manufacture a product, there’s always a possibility that someone could choke on, trip over, fall through, or otherwise injure himself on your product. This opens you up to products liability lawsuits and these kinds of lawsuits can be long and expensive. These also often morph into class action lawsuits. You don’t want to be a sole proprietor defending yourself against a products liability lawsuit.
(3) Do you provide a service related to a person’s health or well-being? If your service is meant to improve health or prevent it from declining, you’ll likely have lots of clients with unrealistic expectations and dire consequences if those expectations are not met. This type of scenario is like a warm and wet place for the bacteria of liability to grow.
(4) Do you have a brick and mortar location? If you have a physical place of business, there’s always the possibility that someone could slip and fall, get robbed in the parking lot, or otherwise injure himself on your property. You don’t want to be personally liable for any of this.
(5) Are your contracts for services worth a lot of money? If you’re signing contracts for $50,000 a piece, you may want to consider forming a business entity. This is relevant for two reasons. If you breach the contract for any reason, you don’t want the party coming after you personally for $50,000. Secondly, if the contract is worth a lot of money, you are probably providing a very valuable service, one that if completed sloppily will cost the client a lot. If you’re in a high risk industry, you want to make sure you’re not personally liable if you’re accused of not holding up your end of the contract.
Again, this is not an exhaustive list, but should be enough to get your gears turning regarding what kinds of things to think about when deciding whether to form a business entity. Every business doesn’t need to form an entity. No need to incur the additional expense (formation costs and annual report costs) and energy (additional paperwork and rules) if you won’t derive the main benefits of forming an entity.
You should also note that if you operate as sole proprietor and use a name other than your own to conduct business, you may need to register your assumed business name in your state. Check with a local attorney to see if this applies to you. If you’re in Cook County, Illinois, I’ve put together this handy guide to help you with that process.