ABA Family Legal Guide

Forming and Operating a Small Business

Types of Business Organizations

Sole Proprietorships

What are the disadvantages of a sole proprietorship?

The biggest problem is that your business assets and obligations are not separate from your personal ones. This means you're fully liable for the debts and other liabilities of the sole proprietorship. Your home, car, personal savings, and other property could be taken away to pay a court judgment. Insurance can protect you against some of the potential exposure to personal liability. But insurance cannot protect you from the claims of creditors and some other types of liability claims. Moreover, adequate insurance coverage may be too expensive for the sole proprietor. Protection against personal liability is one reason why many entrepreneurs choose to operate as a corporation or other business format that has limited liability.

The single-ownership principle, combined with the lack of separate entity status, also creates severe problems when you die. Legally, a sole proprietorship ceases to exist at the proprietor's death. Unless the executor of your will is authorized to continue the business during the administration of the estate, a new owner is found, or the business is incorporated, the sole proprietorship will have to be liquidated. This means your family will lose the going-concern value of the business. Providing an optimum estate plan may, therefore, be more difficult for a sole proprietorship than for other forms of business organizations.

A sole proprietorship also has the least flexibility of all the business forms in raising capital. You can't sell ownership interests to other persons. Your ability to borrow money for the business depends on your net assets.