The Disadvantage of a Sole Proprietorship and a Partnership Is Unlimited Liability

Sole proprietorships and most partnerships are not considered distinct entities.

Most businesses can be classified as either a sole proprietorship, a partnership or a corporation. One single individual musters the resources to start up and then run a sole proprietorship. In contrast, two or more individuals pool their resources and expertise to start up and operate a business in cooperation and for mutual benefit. Unlike corporate shareholders, the owners of sole proprietorships and partners in partnerships are totally responsible for liabilities incurred by their businesses.

Proprietorships

Sole proprietorships are, as indicated by their names, enterprises owned and operated by single individuals. For legal purposes, the owners of single proprietorships are considered the same as their businesses. As such, liabilities incurred by the businesses are liabilities incurred by their owners, and thus their owners are liable for such.

Partnerships

Partnerships pool the resources of two or more interested individuals. However, partnerships are not considered distinct entities from the partners who compose them. As such, liabilities incurred by partnerships are the same as liabilities incurred by their constituent partners. Certain places permit certain businesses to be set up as limited liability partnerships, where partners are protected from legal liabilities incurred by other partners.

Corporations

Corporations are different from proprietorships and partnerships in that they are considered independent legal entities with their existence separate from their owners. As such, when a corporation borrows money, it is the corporation that borrows the money and not its shareholders. Consequently, liabilities incurred by corporations do not pass onto their shareholders.

Unlimited Liability

Unlimited liability simply means that the liabilities of the business are passed on to its owners in full. For example, if a proprietorship is in debt for $20,000 and goes under, its owner is still liable for the entire $20,000. Proprietors and partners possess unlimited liability from their businesses because their businesses do not possess independent existences separate from them.

References

• IRS.gov: Sole Proprietorships
• IRS.gov: Partnerships
• IRS.gov: Corporations