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A reader asksI founded a web company by myself a while ago and for the last six months I’ve been making some serious coin.  I never formed a corporation or an LLC and was wondering, after reading your post last week, if you think I should.  I’m not looking for VC funding, and all the guys who work for me are independent contractors.  Why can’t I just remain a sole proprietorship? It seems like a waste of money to incorporate at this point.

I’m not a big fan of sole proprietorships — and not many lawyers are.

The advantages of running this type of business are pretty obvious.  It’s simple.  There are no legal documents that need to be drafted and no filings with governmental entities (other than perhaps a simple fictitious name or “DBA” certificate if you are doing business under a name other than your own).

Because of this, it’s inexpensive. No legal documents and no filings means no legal fees and no filing costs. There’s also no “double taxation” – meaning, unlike with a C corporation, the business does not pay income taxes separately.  All income taxes are handled on the owner’s personal tax returns.

The biggest disadvantage with a sole proprietorship, though, is that you have unlimited personal liability.  In other words, you as the owner will be held personally liable for all of the business’s activities, including its debts and liabilities, since there is no distinction between the business and the sole proprietor.

With a web business, there may not be a lot of potential liability exposure compared to, say, a medical device company or a real estate owner. However, there could be lawsuits relative to IP infringement, privacy regulations, your contractors (in certain circumstances) and other issues.  If you do get sued, all of your personal assets (money, home, car, etc.) are at risk.

Another major disadvantage of a sole proprietorship is you can’t issue equity to a key employee or an investor. There’s also arguably a greater tax audit risk doing business this way.

The bottom line is that sole proprietorships have limited utility for entrepreneurs. If you’re considering one, be sure the unlimited personal liability and lack of structure for equity issuances are things you’re comfortable with. If they are, I’d definitely advise at least buying some comprehensive liability insurance from a reputable insurer to protect against lawsuits and other claims.

Startup owners: Got a legal question about your business? Submit it in the comments below or email Scott directly. It could end up in an upcoming “Ask the Attorney” column.

Scott Edward Walker is the founder and CEO of Walker Corporate Law Group, PLLC, a law firm specializing in the representation of entrepreneurs. Disclaimer: This “Ask the Attorney” post discusses general legal issues, but it does not constitute legal advice in any respect.  No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction.  VentureBeat, the author and the author’s firm expressly disclaim all liability in respect of any actions taken or not taken based on any contents of this post.

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