As an asset protection attorney I always discourage clients from operating their business as a sole proprietorship. There is absolutely zero protection with a sole proprietorship. One claim against the business can expose all of your personal assets to the risk of attack.
The simple solution is to use a corporation or limited liability company (LLC) for your business. When a claim is brought against your business your personal assets are not in the line of fire.
But there’s another rationale for not operating as a sole proprietorship. Just as your personal assets are at risk — so is your credit. Here are five reasons why.
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1. Lawsuits and Judgments. In a claim against a corporation or LLC the lawsuit is brought against the company, not you personally. Your credit report is not involved. Conversely, a lawsuit against a sole proprietorship is brought against you personally. If the plaintiff (the person suing) wins, that court judgment will show up on your personal credit report. Insulating against such a consequential hit is a significant reason to operate through a corporation or LLC.
2. Building Business Credit. It is the intent of many entrepreneurs to build lines of business credit parallel to their personal credit. While it can take a year or so, in this way they can use business lines without constantly affecting their personal credit. With a sole proprietorship you don’t have this option. Since you are the business all credit remains in your individual name. When you borrow for the business, you are burdening your personal credit reports and scores. The better plan is to form a corporation or LLC and build separate lines of business credit. You are going to grow your business, right? To really grow it you need to get beyond the limits of your personal credit. A sole proprietorship does not afford such an opportunity.
3. Credit Cards. In the same vein, a credit card in the name of the sole proprietorship is just another credit card in your name. You may not need or want another credit card showing up on your credit report. A corporation or LLC can obtain a credit card in the name of the business. While you may have to personally guarantee the first one or two, most business cards are not reported on your personal credit unless you default.
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4. Bank Account. Sole proprietorships allow creditors a direct shot at your bank accounts. Nothing can ruin your credit (or your year) like having your bank account drained. Once again, you are personally liable for any claims brought against your sole proprietorship business. A judgment often allows the creditor to go straight after your personal assets — including all bank accounts in your company and personal name. Don’t be such a target! Set up a corporation or LLC to minimize such risks.
5. Appearances. Are appearances important in business? You know the answer: Absolutely! You want the appearance of steady and stable. You want vendors and other providers to see that your credit is in the name of Josephine Blow, Inc., and not in your personal name. In this way you are communicating that you are serious about your business. You are saying that you are smart enough not to put all of your personal assets at risk and that is an excellent message to send.
So avoid using a sole proprietorship that offers no asset protection, and exposes your credit rating to dangerous cliffs. A corporation or LLC for your business is definitely the way forward.
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Image: Delwin Steven Campbell, via Flickr