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What Are the Legal Risks of Sole Proprietorship?

By George Khoury, Esq. | Last updated on

Starting and running a business is ripe with risks, both to the individual and the business. However, when an individual elects to run their business as a sole proprietorship, they are personally taking on the business's legal risks. The most frequently raised concern of sole proprietors involves their personal liability for business debts.

For example, if a customer is injured, a sole proprietor could be personally sued, and his personal assets seized in a judgment, whereas if the business were structured as a separate entity, the business owner could potentially avoid personal liability. For a sole proprietor, liability is a complex topic and, surprisingly, it can actually cut both ways.

Sole Proprietors Are More Than Married to Their Business

Sole proprietors have a financial relationship with their businesses that, legally, goes as deep, if not deeper, than marriage. A sole proprietor is essentially using their personal official identity as their corporation, and every debt they assume can be held against them personally because they are one and the same entity under the law. What's more is that a sole proprietor's spouse could even be liable for the business debts. Personal liability becomes incredibly significant if a business fails and the assets of the business cannot cover the debts.

Not only can a sole proprietor face personal liability for their business's debts and actions, a sole proprietor's business can actually be held to answer for a sole proprietor's non-business related debts. Again, because the business and owner are the same under the law, a personal creditor could potentially levy a business asset.

Sole Proprietorships Are Mere Mortals

When an individual dies, their estate is divided by will, by the courts, or sometimes both. When a sole proprietor dies, sadly, their business dies as well, and the business's assets pass the same way as the owner's other assets and belongings because they are one and the same.

Unless an estate plan that accounts for continuing the business after death is devised pre-death, a business that is run as a sole proprietorship will cease to exist when the owner dies.

Mitigating Risks

Oftentimes operating a business as a sole proprietorship is just the simplest route and makes sense because of the size or type of business. However, like with any other form of business, risks can be mitigated if you are prepared.

There are simple ways to mitigate risks. For example, you should always maintain proper insurance for your business. Also, you should have sufficient umbrella insurance to cover your home and other personal assets.

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