With me briefly introducing myself and what I’m about in the last post, I wanted to highlight why you should do the same before diving into today’s content. Obviously this content is reaching a wide range of users - some of you may have stable, profitable businesses (perhaps even with formal business education), while for others, your business currently exists solely as an idea in your head.
As a result of this variance, I will be writing this content assuming you have no prior knowledge on these topics. This does two things:
- Nobody gets left behind: building this knowledge base and skillset from the group-up ensures that everyone can understand, follow along, and that we’ll reach that ‘advanced’ level of functional knowledge together. If we started at an advanced level, this would fall apart for our less-experienced members. To the more experienced readers, your patience is appreciated along the way.
- It helps un-learn misinformation. As mentioned in my last post, for many established business owners, education comes in the form of ‘learn by doing’, or in other words, picking up random tidbits as you go. Some of this may be from conversations with others, YouTube videos, or Business Insider articles (hopefully not!). The point is, not all of these sources are reliable, and the people passing that info on may have learned it from unreliable sources themselves, which creates an unintended game of broken telephone - definitely not the sort of info you want to implement in your business or base key decisions on. So while some content may sound basic to you, rest assured that you’re now getting it from a reliable source - which can help correct for incorrect info that you previously had relied on and accepted to be true.
Alright! With that out of the way, let’s get to our first post on business education. Today’s topic falls under the field of business law, and more specifically on legal structure.
Legal systems all over the world provide for different ways to structure your business in the eyes of the law. Each of these options comes with different pros, cons, and intended users. In North America, the default option is called a Sole Proprietorship. This means that unless you take further actions (to be covered in future posts), when you conduct business activities, the legal system (and often its associated tax system) will view you as a sole proprietor. Since this happens automatically, many people don’t even realize that they’re operating as sole proprietors, including some of you reading this!
Anyway, I promised to keep the info concise and relevant, so let’s trim the fat and tell you what you need to know about this structural option:
- The business owner is the business. As far as the law, tax authorities, creditors, employees, etc., the business owner and the business are one and the same, including the default business name. However, you can easily file a form to operate under a separate business name. This point leads to some unique outcomes, as shown below.
- Liability: If anyone wishes to take legal action against the business, they’re doing so against the business owner personally as well. In other words, the business owner bears the full risk of operations. This one is huge, so let me clarify further with an example: If you run a landscaping business, and your employee runs over a customer’s foot while driving a tractor across the lawn, the customer can sue you personally - meaning all of your assets, income, etc. is up for grabs in the courtroom - even if you weren’t there at the time!
- Profits and Taxes: As your business earn profits, you will personally owe tax at the rates applicable for your jurisdiction/tax bracket and all of it is due at the same time as your personal income tax is due. While you can obviously offset the revenue with your related/eligible expenses, you don’t get any other significant tax advantages.
- Transferring Ownership: If you, the owner, die, want to sell the business, or pass it on to your children, well… you can’t. Since you are the business, when you’re out of the picture, so is the actual business--from a legal standpoint. What you’ll have to do instead is sell the assets of the business to the new owner, settle the liabilities yourself (since they’re attached to your name), and handle any tax benefits/liabilities build up over the years yourself.
Aside from the benefit of being the easiest way to ‘start a business’ from a legal perspective, it offers no other advantages to the owner. It exposes the owner to the most risk, least tax advantages, and offers the least flexibility in terms of transferring ownership. For this reason, you’ll rarely see this option used by big businesses. So what do they do? Isn’t there something better? You bet - and we’ll cover that in one of our next posts.