Sole Proprietorship | Kathryn McCall

Yeah. And then again, we get to funding. How is it going to be funded? Financial institutions and investors generally want to invest their money in a structured entity like an LLC or even more popular, the corporation. VCs, they want a corporation and generally it's got to be a Delaware corporation. And when are you planning on seeking those funds? Because it could be in the beginning you can go with a less formal type of entity that I'll explain in a minute and then later transition into a corporation. So think about what's your trajectory and where are you going with, with your company. And then again, the tax implications. Each entity has tax liability. So for some, I've talked about the taxes are going to pass through. Through the entity to your personal income tax return. So any profits, if you earn a profit of $100,000 in your, say it's an LLC, that flows through the LLC and lands on your personal income tax return. Other entities are taxed at the entity level. So if you're a corporation, corporation earns $100,000, the corporation pays taxes On that money. It doesn't go to your personal income tax return. However, if you are drawing a salary from that company, you're going to pay taxes on your salary. If you get a distribution of cash from the company, dividend, whatever, you're going to pay taxes on that distribution. That's what they talk about, the double taxation standard there. And we'll talk about that more. Liability. So, the owner of a business is usually liable for the debts and liabilities of the business. However, there are other types of entities where you, the owner, would not be responsible for those. So, do you want and need that protection? Maybe you don't need it in the beginning, but the minute you go out and get your first customer or you go out in the world and you're now public to the world with your company, You might want that protection. So consider what the risks and liabilities of your entity are. If you're getting customers and you're collecting personal data from them, what's going to happen if that data is disclosed? That's a risk. That's a liability. So if there's a high risk that especially— let's say you've got a healthcare app that you're doing. So you're getting people's medical and healthcare information. If that gets disclosed, huge liability. You violate HIPAA, big liability. So that might justify going to the expense of forming a corporation so that if anything goes wrong, the corporation is liable, but you personally aren't liable as long as you maintain all the proper corporate formalities and nobody can pierce that corporate veil. So start thinking about, do you need to be shielded, do you not? Maybe in the beginning stages you don't need to be shielded. Shielded, but later on you don't. And then recordkeeping. So corporations tend to require a lot of recordkeeping. You've got to keep minutes of your meetings. If you're getting something approved by your board or your stockholders, generally that needs to be done in writing. You've got to have stockholder meetings, board of director meetings. All of that requires paperwork, which keeps me in business. Everybody form corporations. Mm-hmm. But it requires a lot of record keeping. So think about it. Are you good at keeping those records? Are you going to be able to hire somebody and afford to pay them to help you keep those records and give you that advice? So what are the different types of business entities? There's basically 4. There's a sole proprietorship, a partnership, corporation, and a limited liability company. Now, there's different flavors of all of these, but those are your 4 basic types. So, what is a sole proprietorship? If any of you have a business but you haven't— yes? Sole proprietorship. Sole proprietorship? Yeah, until last year. Now it's private. OK. Yeah. So, if any of you have a A business that you're running, doing anything, and it's just you on your own, you're a sole proprietorship. It doesn't really require any documentation to form. It's the most common form of business entity. It's one individual who owns the business. Now, that individual might hire employees, but there's one owner. One person owns it. It's easy to form, and that owner has complete control over the entire business. But also, that sole proprietor is personally liable for the debts and liabilities of the business. So anything that happens with that business, that owner is liable. Also, all the profits and losses from that business flow through and are declared On the owner's personal income tax return. So that's what a sole proprietorship is. If you're doing any type of a business, you haven't formed any sort of formal entity, and you're earning money from it, you're a sole proprietor. So as I said, there's really no formal action needed to form a sole proprietorship. As long as you're the sole owner, You're a sole proprietor. If you choose to operate, you can choose to operate under a different name and still be a sole proprietorship by forming— by filing a fictitious business name. So, let's say I'm Catherine McCall, but my business name is— I'm just looking across— is Magic Touch Salon. I would go down to the county and file and say, I'm Catherine McCall. I'm operating under a business name, Magic Touch Salon. That's my fictitious business name. I advertise in the paper for a couple of weeks. So now my business name is Magic Touch Salon, but it doesn't affect the status of me as the sole proprietor. I'm still the sole proprietor of that business. So what are the advantages and disadvantages of the sole proprietorship? One is it's easy and inexpensive to form. A lot of people unintentionally form a sole proprietorship. There's easy tax preparation. The owner has complete control over that entity. There's no sharing of income. You're not answering to anybody except yourself. Owner makes all the decisions. But with that, you have unlimited personal liability for It's hard to raise money because essentially you're going out as yourself. So you might be able to go to your bank and get a personal line of credit, but most likely if you're going to try and go to a venture capitalist, they're going to be like, I'm going to give you $5 million? Why would I do that? It's just going to go into you. You know, and I'm not going to have any ownership. I'm not going to have any control. I don't want to invest. So you have to be able to show In that type of entity. And it's a heavy burden for that owner. Now, some types of businesses, it's the most appropriate type of entity to be, but think about it. The owner has complete control. There's no sharing of income. The owner makes all the decisions. The entire burden is on that owner. He might hire employees to help him out, but at the end of the day, you know the old saying, the buck stops here. The buck stops at the owner. He's in control. He's the— he's the person. And then as you go along, you might need to change your legal structure as the business grows. So you might need to periodically just think about where am I now? What's my business doing? Maybe I need to transition to a different type of business entity.