What’s the situation?
Nell has just decided to become Farmer Nell. She’s looking at land, she’s circling things in her chicken catalog, and she’s filling out farmers’ market applications. That’s exciting. Then there’s the not-exciting stuff: Nell has to choose how she wants to organize her farm, legally speaking. She has to choose a business entity.
Where does the law come in?
Nell can choose from a few different legal structures for her business. Each of the options has benefits and limitations. Choosing the right business entity isn’t necessarily going to be difficult for Nell, but she will have to consider closely what she wants to prioritize, both now and in the future. The easiest business entity Nell could launch–the sole proprietorship–comes with some very important trade-offs.
First, let me apologize: I tried really hard to write a thrilling opener that would make every farmer say, “Wow, I totally want to know more about business entities!” I tried scare tactics, I tried humor, I tried puns. I failed. This stuff just isn’t very scary, and “sole proprietorship” puns are lame. That’s often the way it goes for us lawyer-types, so all I can offer is the facts: Choosing the right business entity can help a farm hum along smoothly, protect the farmer’s assets, and contribute to the farm’s overall profitability. We all got into this farming thing to make a difference, and the right business entity can help a farmer do just that.
Lets get back to Nell. For a busy new farmer like herself, sole proprietorship offers a very important benefit. It’s simple to establish. Unlike a limited liability company or corporation (more on those later), one measly piece of paperwork is required for the sole proprietorship. Nell needs only to register her trade name, which is whatever title she’s going to use to do business. The point of registering the name is so that the general public can figure out that “Muddy Bird Farm” is owned by Nell. For now, note that the trade name is not the same as a trademark. We’ll get into that later, too. Filing a trade name is a cinch. This task is generally handled by the state’s Secretary of State office, and most offices now allow (or require) business owners to fill out an online form. There isn’t actually any paperwork!
A distinguishing feature of a sole proprietorship is this: There isn’t any difference between the business owner and the business. That’s why Nell might fill out her farmers’ market application as “Nell Smith, dba Muddy Bird Farm.” DBA stands for “doing business as.” In essence, the phrase means that the business is Nell herself, but she calls it “Muddy Bird Farm.” This lack of distinction carries through to tax time. Since there’s no distinction between Nell (as a person) and Nell’s business, the income of the business is passed through to Nell. When Nell completes her annual Form 1040, she’ll attach a Schedule C to account for her income from Muddy Bird. That is why sole proprietorship arrangements are referred to as “pass-through entities.”
But this lack of distinction between Nell and her farm comes with problems. If someone has a legal claim against Nell, there’s no distinction between the farm’s assets and Nell’s personal assets. Let’s say Nell takes out a loan in her first season. In the second season, things get pretty rough and she can’t pay the loan back. If the bank goes to court and gets a judgment against Nell, the bank could get a lien on whatever Nell owns personally, right down to a non-farm vehicle or vacation cabin in the woods. It’s not only debt that can work against Nell. If she hosts a school tour on her farm and one of the kiddos breaks a leg, she could end up with a liability judgment that’s good against the farm and everything Nell owns personally.
Back in the day I started a little catering business making box lunches out of local foods. I chose a sole proprietorship because I figured, hey, all I own is a bicycle, a bunch of student loan debt, two pans, and a couch–let ’em have it! Now, of course, I understand that I can still be liable even if I have no ability to pay. If my lunches made someone sick, it’s pretty unlikely they’d pursue poor little me, but they’d have the right to do so. A sole proprietorship comes with risk. Of course, all that isn’t to say sole proprietorship is bad: That risk is acceptable in some circumstances and unacceptable in others. Nell needs to look closely at her exposure to–and her tolerance for–risk. If those are low, and the value of convenience is high, then sole proprietorship might be a great choice to get Nell off and running.
What do you think?
- Did you choose a sole proprietorship even with its risks? What motivated that decision? Have you looked to insurance to cover accidents instead?
- If you started as a sole proprietorship and then you switched to another entity, what motivated that switch? Was it the risk or something else?