The importance of making the right business entity selection

It can be risky for small business owners to operate as sole proprietors or general partnerships.

Small businesses are the backbone of the economy in Texas and across the country. Many smaller companies are owned by a single person (or a group of a few people) who had a dream of running their own business. Often, start-ups like these are begun with little legal fanfare and are run as sole proprietorships or general partnerships because of the small amount of paperwork involved in getting such an entity up and running. This strategy may prove successful for some people, but it definitely comes with significant personal and financial risks.

Unfortunately - and what most people don't realize - is that the proper business entity selection can play a huge role in the long-term success of a company as well as determining the amount of personal liability that the owner (or owners, in the case of a partnership) will face in the event of a lawsuit or collection action.

The dangers of sole proprietorships and general partnerships

The main issue with operating a business as a sole proprietor, in a general partnership or in a "DBA" ("doing business as") format is the amount of personal legal and financial exposure to which you open yourself. This is perhaps best illustrated with an example.

Let's say that you run a one-man landscaping business as a sole proprietor. You mow lawns, tend gardens, plant flowers, design landscape plans and perform other related services. One day, tragically, you - and your industrial-grade lawn mower - are involved in an accident with a client. The client secures a judgment against you for $1.5 million in compensation for his injuries. Your insurance policy "caps" payments at $1 million.

Because you are the owner, and you operate as a sole proprietorship, you and the business are seen as "one and the same" under the law. This means that not only are all your business' assets (trucks, tools, other equipment, the building you purchased as an office and storage space, etc.) on the hook to satisfy the remaining $500,000 of your client's judgment, your personal assets will also be subject to seizure if necessary.

This same scenario would be possible if you and others are operating a business as a general partnership, and the issue is actually magnified in that case. In a general partnership, all partners could be held responsible for the legal liability of all other partners, whether business-related or personal in nature. If, for example, one of your partners is involved in a drunk-driving accident and faces a lawsuit, if there are insufficient business assets to cover a verdict - yours and the other partners' personal assets could be at risk.

How does a different business entity selection change things?

By simply converting from a general partnership or sole proprietorship to a limited liability entity like a limited liability corporation (LLC), corporation, limited liability partnership (LLP) or limited liability limited partnership (LLLP), you can prevent being held personally responsible for business debts. This means that you can shield your personal assets from being taken to satisfy business-related or personal liabilities incurred by your fellow owners.

There are pros and cons to every business entity, and what works for one business might not be the best fit for yours. That is why it is important to speak with an experienced business law attorney - like those at the Dallas law office of Palmer & Manual - before launching your company. Contact the firm online or call them at 214-242-6444 for more information.

Keywords: business formation, business entity, entity selection, limited liability company, partnership, sole proprietorship, limited partnership