Unlimited Liability: Why Sole Proprietorships & Partnerships Must Be Careful

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All business take on risk, but the degree varies. If you’re running a business that does not involve you taking loans or entering into deals involving large liability (relative to your net worth or earnings of your business), a sole proprietorship or partnership would suit you just fine. In fact, it could be better than running a private limited or one-person company or limited liability partnership. This is because these business formations are expensive to start and have a long list of regulations that need to be complied with on an annual basis. This is not so for sole proprietorships or general partnerships. If the risk, however, is large, this argument does not hold. Here’s why:

Personally Liable
Sole proprietors and partners have unlimited liability. This means that if you’re unable to repay the debts of the business, your creditors can go after whatever you own. So you could lose any of your possessions that would allow them to recover the amount. Surely this is not something you would want to risk if you’re running a business that involves sums larger than you can handle if something goes wrong. Therefore, a sole proprietorship or general partnership should only be run on a small scale. If you’re a trader or running a home business, go for it. But anything larger and you might be making a mistake.

Not a Separate Entity
Sole proprietorship concerns and general partnerships do have their own names, but they aren’t separate legal entities. Private limited companies, OPCs and LLPs, on the other hand, have a legal existence on their own. This is why proprietorships and partnerships usually cease to exist if the promoters leave. This is not the case with registered businesses as they have a life of their own, which also means that the directors or partners running them do not have unlimited liability. Their liability is limited only to the extent of their contribution to the business. Their personal possessions can never be touched.

Therefore, even if you’re already running a sole proprietorship or partnership, you should regularly come back to this question: can I handle the risk personally? If the answer is no, go ahead and register a private limited company. If the risk your business is taking is large, we’re sure that your earnings are enough to justify the additional expense on compliance (which can be as low as Rs. 30,000 a year, after accounting for even auditing costs).

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Vakilsearch's resident expert on starting up, compliance and accounting, he holds a Masters in Accounting and an LLB.

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