Chapter 4 Sole Proprietorships

Introduction This chapter covers sole proprietorships, the most common form of business organization. The most significant advantages of the sole proprietorship are the simplicity of formation and the informality of management. The greatest disadvantages are the personal liability of the sole proprietor and the involuntary termination of the business upon the death of the proprietor. The majority of business clients will begin as sole proprietors, at least until such time as they seek legal advice regarding their options. Paralegals must be able to determine if and when a sole proprietorship would be the most appropriate business form for a given client.

Lecture Notes Sole Proprietorship Defined

A sole proprietorship is a business conducted by one individual. Advantages simplicity of formation flexibility of management Disadvantages involuntary termination upon proprietors death unlimited liability of sole proprietor

Formation
Sole proprietorships are formed simply by beginning business. Unlike many other business organizations, no formal documents must be filed with the secretary of state to create a sole proprietorship. Registration of Assumed Business Name If a sole proprietorship intends to operate under a name other than the owners name, the owner must register the assumed business name or trade name with the
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secretary of state to (1) reserve use of the name and (2) prevent other businesses from operating with deceptively similar names.
Example: McDonalds is a national fast-food hamburger establishment. Donald Kipp, a local resident of your state, wants to open a fast-food chain with the name McDonalds Place. His sign will have large golden arches with a red background. Assuming that McDonalds has registered their assumed business name with the secretary of state, they can prevent Donald from using the name McDonalds Place because it would cause consumer confusion (i.e., consumers may view the two chains with similar names as related).

Licensing Business Licenses The secretary of state and the counties in which a business is operating may require a business license. The purpose of such licensing is to regulate businesses, maintain business standards, protect existing business interests, and protect the public (e.g., by requiring background checks on companies that intend to work in residential environments).

Management
Sole proprietorships are managed at the policy level by their owners. Many sole proprietorships, however, hire employees (agents) to run the daily operations of their business.
Example: Holly owns a bakery. Holly first started her business from her kitchen at home, making cakes and pies for a restaurant her sister owned. Soon, people all over town started asking her to bake desserts for their businesses. Hollys business was rapidly expanding, so she rented a storefront and officially opened Hollys Hot Cakes. She hired a manager to run the store, to allow herself to be at home with her small children. She also hired several college students to make the pies and cakes from her recipes. While Holly made the policy decisions (what kinds of cakes and pies to make for her store), her manager actually implemented the policy (hired and supervised employees, ordered supplies, etc.).

Liability
Sole proprietors are personally liable for the debts and obligations of their business. business liability: business assets (desks, chairs, bank accounts) personal liability: personal assets (home, cars, savings accounts)

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Contract Liability Limitations A sole proprietor may limit, to some degree, personal liability that may result from a breach of contract. The following language, if inserted into a contract with others (such as vendors, etc.), may limit the owners personal responsibility for business debts: Obligations due on or created by the contract, or a breach thereof, will be limited to and payable solely from the businesss assets. Personal assets of proprietor shall not be liable for debts created by this contract, or a breach thereof. Note: Obviously, this doesnt work in the event of a tort (e.g., accident).
Example: Joe owns a floral shop. His driver hits a pedestrian during a delivery. Clearly, the pedestrian can sue Joes floral shop for the injuries. Joe should, of course, carry liability insurance for such situations.

Bonding and Insurance Sole proprietors can limit the personal liability through bonding and liability insurance. While both are forms of insurance, their purpose is different. Bonding ensures that a contract will be performed; liability insurance protects against damage, theft, torts, and so on. bonding: ensures performance of contract liability insurance: protects against losses and damage (property damage, theft) Disadvantages Bonding may not be available to high-risk or new businesses. Additionally, it is very costly for many businesses (e.g., businesses that deal with small children) and therefore may be cost prohibitive.

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 Taxation Considerations
Sole proprietorship business profits = personal income of the sole proprietor Taxing the business profits as personal income allows business owners to offset business income with other losses.

Termination
Upon Death A sole proprietorship automatically terminates on the death of the sole proprietor because a sole proprietorship is merely an extension of the individual. Upon Sale Valuation of a business is based on the tangible assets (tables, chairs, etc.) as well as the general reputation of a business (the goodwill). Valuation: business assets + goodwill (reputation) Sale Price: look to other business sales or business income for specified time

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Answers to Study Questions in Review

1.

How is a sole proprietorship formed? A sole proprietorship is formed automatically when one person begins business. Although most states require sole proprietors to register the name of the business if the business is operating under an assumed business name, this is not required for the formation of a sole proprietorship.

2. Are there any advantages to registering an assumed business name before a prospective business begins operation? Yes. It reserves the name for the prospective business. 3. Why do some states and counties impose licensing requirements on businesses? Business licenses are generally required for regulatory reasons, in order to allow the government to provide some measure of safeguards for the consumer as well as the business owner. 4. What is a sales tax permit? A sales tax permit allows state and local governments to monitor (impose and collect) taxes due on the sale of goods.
5.

What does the term personal liability mean? Liability refers to who is responsible for paying debts and obligations. Personal liability means that an individual, such as a business owner, is personally responsible for the debts and obligations that he or she incurs, including debts and obligations that a business incurs.

6. Explain the difference between bonding and insurance.

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Bonding is a form of insurance that ensures the contractual obligations of the proprietor will be performed (e.g., even if the proprietor does not finish painting a house that he or she contracted to paint, the bonding company will hire another painter to finish the job). Insurance is designed to protect an individual from unforeseen risks and liability to third parties for such things as property damages, theft, etc.). 7. Who pays the taxes due for the income earned by a sole proprietorship? The sole proprietor. The business is not taxed on its income. All income earned in a sole proprietorship is considered the personal income of the sole proprietor.

Answers to Case Studies in Review 1. Jeremy wants to open his own residential plumbing and heating business. He learns through an acquaintance that the county where his business is located requires residential plumbers to obtain a business license; the cost of the license is $250.00. Jeremy believes that the only purpose of the licensing requirement is simply to fill the governments pocket. Can you offer any other reason why the county would want to regulate a residential business such as Jeremys? To provide some measure of safety for the customer or consumer, governmental agencies may impose licensing requirements on business owners who intend to do business in a residential setting. Businesses that intend to operate in a residential setting may have background checks run on the owners and employees to safeguard consumers from known felons, especially those with a record of violent crimes.

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2.

Doreen is the sole owner of Doreens Flowers, a local floral shop. While one of Doreens drivers is delivering flowers in the business van to the local hospital, he hits a pedestrian at an intersection, severely injuring the pedestrian. Doreen is sued for the personal injury damages suffered by the pedestrian (medical expenses, pain and suffering, etc.). A jury awards the injured pedestrian $250,000.00, due from Doreens Flowers. Doreens Flowers has no insurance to cover the jury verdict. Who is responsible for paying the $250,000.00? Doreen. Sole proprietors are personally liable for the debts and obligations of their businesses.

Project Applications 1. Contact the secretary of state and obtain the forms required for registering an assumed business name or trade name. Complete the form for the following sole proprietorship:

Copy Stop 3444 Northwest Blvd. Georgetown, (your state) 55555 Owner: George Denny 55 Buckskin Way Savannah, (your state) 55555

2. Visit the county licensing bureau and determine what licenses and permits would be required for a residential cleaning business that intends to do business in your county and a neighboring county. Compile these forms and present them with a how-to manual for your supervising attorney.

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