Consider sole proprietorship for a lean startup

Consider a sole proprietorship with liability insurance over a Limited Liability Corporation (LLC) for a lean startup.

When an entrepreneur first sits down to consider how to incorporate a business, the technical details may bore her to tears. That is, until she reads about liability and begins to imagine what horror stories may apply to her. Lean startup entrepreneurs want runway to iterate on their business model until a product/market fit is achieved. They’re willing to invest in the idea and risk the possibility that they will not identify a model before their resources run out, but few also sign up to expose their family’s equity to liability risk in the process. The startup may eat their investment with little to show for it, but it’s another layer of risk to put the family’s assets on the line. The incorporation options which create a separate entity, such as an LLC or S corporation, are a tantalizing option for the entrepreneur that doesn’t want to risk their life’s savings on a single venture. But is that the only option?

Before the entrepreneur decides she can’t afford the risk of the simpler sole proprietorship, she may consider the cost of liability insurance. TechInsurance estimates that the average cost of general liability insurance is $483/year for a single employee. This cost may scale as the company hires employees, but $40/month to satisfy the entrepreneur’s fears is a small price to pay for the advantages that pass-through taxation and a simplified incorporation process offer.

Contrary to popular rendition, entrepreneurs are not typically willing to risk their future on one long-shot idea. The fear of personal liability and complexity of LLC incorporation may hinder the aspirations of cautious entrepreneurs whose insights could bring enormous benefit to their customers and communities. The availability of general liability insurance offers cautious entrepreneurs a chance to form a sole proprietorship, invest a portion of their savings in pursuit of a business model, and reduce the fear that a poor business decision by any member of their business will place their family in crippling debt. Armed with this news, a sole proprietorship can afford to take appropriate risks, such as hiring an employee or investing in semi-dangerous equipment.

Entrepreneurs who incorporate a sole proprietorship gain advantages over the same business as an LLC. Reduced paperwork overhead launches their business into the market faster and keeps it running lean. The greatest benefit; however, is the advantage of pass-through taxation. By gaining the profits of the company directly into the entrepreneur’s coffers, she avoids double taxation. While there may be a few entrepreneurs whose motivation is not bolstered by a healthy income, most will only be more motivated at the chance for more money in their pockets.

Liability influenced Tommy, Matthew, and I to start a member-led LLC. We trusted one another implicitly, but when we realized that a formal partnership extended liability for each of our business decisions across all three of us, we skittishly chose to create a separate entity. This may still have been the best option, and the absence of revenue never made taxation an issue for us, but in hindsight I suspect the complexity of our business transactions and underlying fear of doing something wrong hindered us more than it needed to. I’ve been considering incorporation as a means to prepare for consulting opportunities that may arise, and from previous experience have thought LLC is the only safe bet. However, a sole proprietorship better matches my needs, reduces my up-front expenses, and allows me greater flexibility. I’m reconsidering my preference for limited liability in favor of this more flexible option.

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