What Is Sole Proprietorship Liability?

A sole proprietorship is the easiest business structure to start, however a sole proprietorship, with regards to the law,  is not a separate legal entity from the owner. This means that the business owner is responsible for any issues of money owed by the company as opposed to other business structures where the owner is protected.

Key Points:

• If you are starting out small and testing the water with your idea and do not expect large revenues nor having to finance growth (therefore potential debt) you need not be concerned with the personal liability for now. 
• If your business starts generating sufficient income and financing becomes necessary this is the time to start considering how to protect yourself.

What Kind of Liability Does a Sole Proprietorship Have?

Sole proprietorship liability stems from the fact that there is no legal separation between the owner and the business. With that, the owner is on the hook for any debts or damages incurred by the business. 

The liability facing sole proprietors can be broken down into two separate types: unlimited liability and vicarious liability. 

What Does Unlimited Liability for Sole Proprietors Mean?

Unlimited liability for sole proprietorship means that the owner is personally responsible for all debts and lawsuits facing the business. 

• No legal distinction: In the eyes of the law, the sole proprietorship and the business owner are the same entity. With that, the business owner is personally responsible for all of the obligations.
• Creditors can seize your personal assets: If your business cannot keep up with the payments, a creditor may seize your personal assets.

Example of Unlimited Liability

Here’s what sole proprietorship unlimited liability looks like in real life.

• Example one: Let’s say that you open a new business as a sole proprietor selling candies online. You borrow $5,000 to pay for equipment to manufacture the products. Unfortunately, your candies aren’t a big hit. Since your business cannot cover the debt payments, you must personally cover the costs. 
•  Example two: Let’s say you own a successful boutique hotel as a sole proprietor. Business is booming, so you forget to block off a recently mopped area. A guest hurts themselves when they slip on the slick area. Unfortunately, they sue you to cover the medical costs. Since you are a sole proprietor, you’ll be personally responsible for paying the lawsuit’s settlement unless your business can pick up the tab. 

What Does Vicarious Liability for Sole Proprietors Mean?

Vicarious liability means that one entity is held responsible for another person’s actions. Since sole proprietorships can hire employees, sole proprietors are held responsible for the mistakes of employees.

• The employer could be held responsible for employee actions: When an employee makes a mistake on the job that harms someone, an employer could be held responsible if the actions were within the scope of their employment. 

Example of Vicarious Liability

Here’s what sole proprietorship vicarious liability looks like in real life.

• Example:  Let’s say that you own a boutique hotel as a sole proprietor. You hire Sally as a valet for guests. One night, Sally crashes a guest’s vehicle while trying to park it. The upset owner of the vehicle sues you. Although Sally crashed the car, it happened while Sally was working as an employee of your hotel. So, as a sole proprietor, you are responsible.

Why Might Someone Sue Your Sole Proprietorship?

There are many reasons why someone might sue your sole proprietorship. But we cover some of the most common reasons below:

• Contract violations: If you violate the terms of a written or oral agreement, the other party may sue to recover their costs. 
• Physical injury: If a customer or employee is hurt by your business, they will likely sue. 
• Financial damage: If someone loses money as a result of your business practices, your sole proprietorship could face a lawsuit.    

Who Might Sue Your Sole Proprietorship?

As a sole proprietorship with unlimited liability, there are several parties that might sue you:

• Employees: An employee can sue you for any number of reasons. A few include discrimination, sexual harassment, wrongful termination, and more. 
• Landlords: Landlords and tenants often disagree on issues. Sometimes the disagreement ends up in court. 
•  Suppliers: If you aren’t paying on time, a supplier may sue you. 
• Vendors: If you aren’t providing the agreed-upon goods and services, then a vendor might sue you. 
•  Customers: A customer can sue for physical damage, contract breaches, and more. 

Ways to Protect from Liability in Sole Proprietorship

Sole proprietorship unlimited liability is a serious concern for most business owners. Here’s a closer look at the ways to protect yourself. 

Obtain Liability Insurance

Sole proprietorship liability insurance is a popular way to protect yourself.

• Professional liability insurance: This insurance policy protects sole proprietorships in the event of negligence, inaccurate advice, misrepresentation, or the failure to protect personally identifiable information. 
• Costs: On average, professional liability insurance costs small business owners as low as $22.50 a month. 
• Coverage: The policy may cover legal costs, defense fees, and lost income. 
• Other coverage to consider: In addition to professional liability insurance, you may want to obtain general liability insurance or an umbrella policy to protect your personal assets further. 

Protect Your Assets

Even with the appropriate insurance, your assets are still at risk while running your sole proprietorship. Here are other ways to protect your assets:

• Transfer the deed of your home: Instead of keeping this large asset in your name, transfer it to the name of your spouse or parent. 
• Transfer ownership of other valuables: You can transfer the ownership of other valuable items to protect them in case of a lawsuit. 

Hire Independent Contractors

You can hire employees. But from a liability perspective, it makes more sense to hire independent contractors:

• Independent contractors are responsible for their own actions: As a sole proprietor, you generally cannot be sued based on the actions of an independent contractor. But the exact rules vary based on the state. 
• Smaller opening for employment lawsuits: Since independent contractors operate independently, there is less of an opening for employment lawsuits. 

You might to wish to explore the distinction between sole proprietorship vs independent contractor in greater depth.

Create an LLC

If you are worried about the risks to your personal assets, then consider creating an LLC. See how to change from sole proprietorship to llc.

• Limited Liability Company (LLC) limits risk: An LLC is a separate legal entity. With that, the business owner is not personally responsible for business debts and lawsuits. 
•  More paperwork to maintain: Although an LLC limits risk, it increases the amount of paperwork to keep up with.

FAQs about Sole Proprietorship Liability

Do you still have questions about sole proprietorship liability? Here are the answers you’ve been searching for.