Sole proprietorship does not have limited liability protection. Instead, the sole proprietor has unlimited liability. This means that the sole proprietor is personally liable for the debts and expenses of the business.Â
If the business is sued, the sole proprietor risks losing his personal assets. To protect their assets, a sole proprietor should consider obtaining a business liability insurance policy.
What Is A Sole Proprietorship?
The term sole proprietorship is used to describe a business that is owned and operated by one person, called a sole proprietor or sole proprietor. For legal and tax purposes, a business does not have its own identity.
A sole proprietorship and a business are considered one and the same. Sole proprietorships are popular because they are the easiest and cheapest business structure to set up.
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How Does Sole Proprietorship Work?
A sole proprietorship is a popular form of business due to its simplicity, ease of creation, and nominal cost. A sole proprietor only needs to register his name and obtain local licenses and the sole proprietor is ready for business.
However, a significant disadvantage is that the owner of a private enterprise remains personally responsible for all the debts of the enterprise.
So, if a sole proprietorship is facing financial difficulties, creditors can sue the owner of the business. If such lawsuits are successful, the owner will have to settle the company’s debts with his own money.
The owner of a sole proprietorship usually signs contracts on his own behalf, since a sole proprietorship does not have a separate legal personality. A sole proprietorship usually forces customers to write checks in the owner’s name, even if the business uses a fictitious name.
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What Is Sole Proprietorship Liability?
The biggest disadvantage of running a business as a sole proprietor is the responsibility that rests on you. If your business has debts that it cannot pay with profits, you are personally responsible for paying them.
Creditors can sue you personally to collect the debt. The opposite is also true. If you have unpaid personal debts, the creditor may demand the profits or assets of your business to pay off the debt.
In addition to liability for debts, as a sole proprietorship you are also personally liable for any wrongdoing or injury that occurs as a result of any acts or omissions of your business.
However, you can purchase liability insurance for your business, which can help eliminate liability for wrongdoing.
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How Does Sole Proprietorship Liability Work?
State laws vary slightly regarding business entities; however, the general principles regarding liability across states are similar. A general partnership will not provide liability protection, but a limited partnership often can.
However, a limited partner also usually has limited control over the business. A corporation or one of the corporation’s entities, such as an S corp, will in most cases provide personal liability protection to the owners. Consult an attorney to determine which entity is right for your business.
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Sole Proprietorship Liability Insurance
Specially designed for the busy solopreneur, sole trader insurance is a policy package that protects against the risks associated with running an unincorporated business, such as negligence, third party injury or property damage.
This coverage is designed to cover the liability of sole traders in many different industries. As a sole proprietor, there is no separate legal entity between your personal and business assets.
In simple terms, this means that you are responsible for all the risks of your business, and these may extend to your personal property and assets. Scary things, and that’s why it’s important to protect your business.
Different businesses have different risks; for example, a freelance writer or designer will not need the same type of coverage as an independent construction contractor, such as a plumber or handyman. However, we know what it takes to find the perfect coverage for your specific business.
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Sole Proprietorship Liability Of Owners
The liability of the individual owner is unlimited. As there is no legal distinction between the business and its owner, this means that the owner remains fully responsible for any debts incurred by the business.
If you are self-employed and make a bad business decision (or many) then you are likely to be responsible for any debts. If you are unable to pay, your assets may be liquidated, including your personal and real property.
While priority may be given to your business assets, don’t count on creditor leniency. If you run a business where the risk of going into debt is high, sole proprietorship liability can put you at a serious disadvantage.
In these cases, you should consider looking for alternatives that can protect you from liability. It may make more sense for you to register your business as an S corporation or limited liability company (LLC).
Both are considered separate legal entities and as such they alone will be liable for any debts incurred in the business. Of course, the disadvantage is that they are more complicated and require a certain amount of documents to create.
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Sole Proprietorship Liability Protection
As a business owner, no one wants to suffer catastrophic financial consequences due to liabilities that could otherwise have been avoided. Here are ways to protect yourself from such liabilities.
Get insurance
There is business liability insurance that can perfectly protect a sole proprietor from liabilities such as lawsuits that would derail the business and deplete personal assets.Â
This can be an expensive option, especially for small business owners. But it can protect sole proprietors from many events that can be financially devastating to a business.
Another way to protect your business from lawsuits is to have your customers sign a liability waiver in case they are injured as a result of risky activities that are part of the services you offer.
Protect your home from liability
In many cases, a person’s home is his/her most valuable asset. It will be the target if a massive liability lawsuit arises. With this in mind, protecting your home from the liability associated with running a sole proprietorship business will be a top priority.Â
For married individuals, it may be a good idea to consider changing the title of the home to include you and your spouse as tenants by the entirety.
This would mean that ownership is split 50-50. This would then effectively prevent creditors from foreclosing on the property. This is as the debts only apply to you personally as the sole proprietor of the business, not your spouse.
On the other hand, single sole proprietors may consider owning a home with someone other than your spouse, say your parents. Keep in mind that this provision is always different depending on the laws of each state.
Hire independent contractors
Under most business laws, a sole proprietor is not liable for damages or negligent acts caused by independent contractors.
In this regard, a sole proprietor may consider hiring the services of an independent contractor for all staffing needs rather than employees.
However, be aware that this provision may vary from state to state, especially when it comes to negligence.
For example, sole proprietors in California may be liable for the negligence of a contractor if the work for which he/she hires the contractor is inherently dangerous.​
Create an LLC
While all of the above methods can protect the sole proprietor and his/her business from liability, the most effective and least expensive way to protect against liability is to effectively change the business from a sole proprietorship to a limited liability company (LLC).
An LLC has numerous benefits not only for the business, but also for you as a business owner.
This gives you the chance to separate your business entity from your personal activity. It means creditors cannot use your personal assets to pay off the company’s liabilities.
Sole Proprietorship Liability Limited Or Unlimited?
Individual entrepreneurs and partners have unlimited liability. Unlimited liability means that if you are unable to repay the company’s debts, your creditors can go after everything you own. So you can lose any property you own that will allow them to recover the amount.
Of course, this is not something you want to risk if you run a business that involves more than you can handle if something goes wrong. Thus, a sole proprietorship or general partnership should only be established on a small scale. If you are a trader or run a home business, go for it. But if anything more, you can make a mistake.
Conclusion
Sole proprietorships and general partnerships have their own names, but they are not separate legal entities. Private limited companies, OPCs and LLPs, on the other hand, have a legal existence of their own.
This is why owners and partnerships usually cease to exist if the promoters leave. This does not apply to incorporated companies as they have a life of their own, which also means that the directors or partners managing them do not have unlimited liability.
Their liability is limited only to the extent of their contribution to the business. Their property should never be touched.
Sole Proprietorship Liability FAQs
How Is A Sole Proprietor Affected By Insurance?
Sole proprietors have the same legal obligations as corporations and are generally eligible for protection under most small business insurance policies. For example, if a service they provide for a customer has a negative financial impact or causes property damage, the customer can file a lawsuit. In this case, professional indemnity insurance or errors and omissions insurance can provide financial protection.
What Is The Downside To Operating A Business As A Sole Proprietor?
The biggest disadvantage of running a business as a sole proprietor is the responsibility that rests on you. If your business has debts that it cannot pay with profits, you are personally responsible for paying them. Creditors can sue you personally to collect the debt.
What Are The Benefits To Operating A Business As A Sole Proprietorship?
The advantages of running a business as a sole proprietor are numerous. In most cases, a sole proprietorship requires very little capital to get started because it does not require any court fees or formal legal maneuvers. In addition, a sole proprietorship allows the owner to avoid the often high tax rates at which corporations are taxed.
