Many times people start out in the creative field part time or with great uncertainty as to whether they are going to “make it” in business. For these reasons, many of you may be sitting on a dangerous risk pile of sole proprietorship (SP) formation.
Yes, because I will undoubtedly get emails saying there is a time and place for SP businesses. You are correct, however, I don’t feel comfortable recommending such a risky formation even with iron-clad contracts and insurance contracts. I present this article with the understanding that not each of you has the money or know-how to be a Limited Liability Company (LLC) or a Corporation, but I want to encourage the understanding into the risks of being a SP so that you can make a game plan to grow out of that formation.
What is a Sole Proprietorship?
Colloquially, it’s having all your business and personal assets thrown into the same bucket. There’s not separation and there’s no liability protection arising out of the formation. SP is quite a streamlined process. In fact, many times people create SPs without realizing it. SP is the default formation that occurs when you’re in business (whether you are full time, part time, or just acting like it on any timeline). State laws vary on formation requirements, but this formation is most commonly found since it is the “default” and other formation types require overt filings and payment to receive those benefits and protections.
#1 Liability Risks
While SP is arguably the easiest and least expensive option, it also brings with it very little benefits. Sure, you’re a formed business and may have ease of filing taxes, but there is an uphill battle trying to take your personal assets out of that “bucket” when an issue arises so your personal life isn’t touched. At formation, LLC and Corporations give you two buckets – personal and business. All of the assets are separated. Note: You’ll be afforded liability protections if you avoid piercing the corporate veil (you can read more about piercing the corporate veil here).
#2 Access to Capital
If you reach a point in business where you need to acquire financing, whether through loans or other individuals, sole proprietorships can have a difficult burden to demonstrate the value of the investment. Further, a sole proprietor cannot bring on partners as that would require a change in formation.
#3 Business Termination
Should the individual become incapacitated or deceased, the business ceases. A SP is tied to the individual and is not a “passable” entity.
#4 Personal Bankruptcy/Credit Risk
Unlike other formations, all of the business credit goes under the SP as an individual. When an SP “goes under” and needs to file bankruptcy, it has to be done with the personal assets as well, not simply just the business assets. Remember, no separate bucket protection here! Further, should a “business” expense fall into collections, a creditor can collect judgment from the bucket that includes personal assets.
#5 Lose Tax Benefits
With LLC (with Corp election) and Corporation formations, there are tax benefits that can help the business (and you!) save money paid on taxes. Sole Proprietors do not receive the same tax benefits that incorporated businesses do, and you may end up spending more than needed.
As you can see – sole proprietorships may have a place in your business timeline, but for a limited period of time. It is best to seek LLC or Corporation options to receive all the benefits and protections available to your photography business.
Need more help?
This stuff can be really confusing. BizRevamp® is an online course by yours truly, photography and lawyer – to help you understand business formation, taxes, contracts, insurance, retirement and more.
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