Basic Characteristics of a Sole Proprietorship and General Partnership

Sole proprietorship and general partnerships are easy to create and manage

The sole proprietorship and the general partnership are the default entities if you don’t choose to officially form another entity. If there’s just one person involved, it’s a sole proprietorship. If there is more than one person involved, it’s a general partnership. You don’t need to do anything to actively form it. For the most part, there are no filings and no paperwork.

However, some registrations, licenses and permits may be required. For example, if the farm operation wants to operate under a different name than the name of the owner(s), then it will need to file a name registration form with the county or state agency that manages what’s called fictitious business names in your area. This is also called a “DBA” or “doing business as.” In addition, most cities and many counties throughout the country require all businesses–even small farm-based sole proprietorships–to register and get a business license or a tax registration certificate. The local agency may also require the business to pay a minimum tax. Also, if the farm operation has employees, it must obtain an Employer Identification Number or “EIN” with the IRS. This is used for monitoring and paying required employment taxes. States may also require the farm business to get a seller’s license before selling anything to the public, and the local planning board may require the farm business to have a zoning permit depending on the location of the farmland.

These are essentially simple forms that all businesses in a given area have to file. Other than that, the sole proprietorship or general partnership is ready to go.

The personal assets of the owners are NOT protected from the business’s liabilities

Nothing good seems to come without a trade-off. This is the case here. Unlike with a C corporation or an LLC, the personal assets of the owner(s) of a sole proprietorship or general partnership are available to cover the debts and liabilities of the company. Basically, this means that if the farm business starts struggling and is not able to pay its debt, doesn’t pay a supplier when the money is owed, or has to defend itself in a lawsuit brought by an employee, the creditor or court can legally come after the owners personally and grab hold of their assets. While bankruptcy laws for the most part protect primary homes, the creditors can most likely access personal bank accounts, cars, vacation homes, boats and other such things of value. Some folks think they don’t have any assets, so it’s fine. But, a court judgment–whether related to debt to a creditor or damages to a defendant– can extend to future owned assets, including wages. Basically, if the creditor has received a judgment from a court that you owe money, the creditor can file papers to have a portion of your paycheck garnished (taken or withheld) to pay off your debt. However, the creditor cannot take the part of your paycheck that you need to support yourself and your dependents.

The sole proprietorship provides no protection over personal assets

An example here will help illuminate this risk. Let’s say that Judy runs a small dairy farm over the summer. The seasonal dairy farm has been mostly a hobby for her, as she loves taking care of the cows and loves making cheese. She’s a school teacher, so the schedule is perfect for her. The farm itself is about two acres that she leases from her neighbor. It’s located just down the road from her house that she bought just a year ago. She has another house in the city that she hasn’t been able to sell yet. Judy mostly sells her cheese at the local farmers’ market and to two local restaurants. She’s been in business for about two years and has two Brown Swiss cows and two Jerseys. This summer Judy decided to hire a part- time volunteer to help her with the milking, as she wanted to focus her efforts on refining her cheese recipes. Her friend’s daughter, Katie, was in town from college and was eager to help. Katie had some experience with milking cows, but it was years ago when she was a kid visiting her grandparents’ farm. Judy encouraged Katie to stick with the Brown Swiss until she got used to it, as the Jerseys were notorious kickers. One day, just two weeks into her volunteer gig, Katie got the guts to milk one of the Jerseys. Just as she finished and walked around back, the Jersey kicked her right in the chin. Ouch! Turns out she lost about five teeth and had to get reconstructive surgery of her jaw.

While Katie didn’t make anything of it, when she was at the hospital filling out the paperwork, she reported that the incident occurred on Judy’s farm while she was at work. Without her knowing, Katie’s health insurance company did an investigation and filed a claim against Judy to recover the cost of the medical bills, which were $25,000! Judy didn’t have that kind of cash, and she didn’t have insurance to cover such a claim. Katie’s insurance company was relentless and took her to court. After a long and drawn-out trial, the judge entered a judgment against Judy for the full amount of the medical bills. Meanwhile, the state department of labor started to investigate Judy’s farm operation. It concluded that Judy failed to treat Katie as an employee, and it issued a fine and required her to pay back wages at the minimum wage rate and employment taxes.

In this circumstance, the court could put a lien on Judy’s house in the city since it’s no longer her primary residence. Also, the court could garnish a percentage of Judy’s wages from her teaching job. If Judy had formed an LLC or a C corporation, these personal assets would have been protected from the business’s liabilities. The reason this happened to Judy is because there’s no distinction between the person and the business when it is a sole proprietorship. They are one and the same. On the plus side, the individual farmer is the business. Some farmers prefer the authenticity and integrity that comes with such a personal identity with the farm operation. However, this means that everything you have is vulnerable.

The problem is magnified for general partnerships

For general partnerships, not only are your personal assets available to cover the business liabilities related to your own actions, they also apply to commitments your partner(s) made. This means that individual partners have joint authority and joint liability. When it comes to authority, each individual can usually bind the whole farm business to a contract or other business deal. As for joint liability, each individual partner can be sued for–and required to pay–the full amount of any business debt. So if you have more personal assets than your partner, you are particularly at risk. Your only recourse may be to sue the other partners to recover their share of the debt. But if they have no money, doing so would be futile. Recall, too, that a general partnership is the default entity and can be formed without you even knowing it. A court may decide, based on the fact that you have gone into business with another person, that you have a partnership over the farm operation’s obligations.

Again, an example can be helpful here. Let’s say that Joe and John are brothers and they’ve been operating an organic vegetable farm for the past decade on a 20-acre farm property that was handed down to them and their two sisters by their parents. They haven’t been turning much of a profit, but they get by just fine. John is also a math professor at the local community college and makes a pretty good living on the side. He teaches mostly in the winter, so he’s able to spend a significant amount of time on the farm during the growing season. John also has a mountain house and enjoys spending long winter weekends relaxing up there. Joe doesn’t have a second job and just tries to live simply. Joe and John decide they should get a greenhouse so they can provide produce year-round. John puts Joe on the project and they agree that they have about $3,000 to spend on it. Joe goes online to do some research and gets a bit carried away. He chooses a 500-square- foot greenhouse that costs $30,000. The greenhouse company offers a three-year payment plan at a cost of $1,000 a month, including interest. The greenhouse arrives and Joe assembles it. John notices how amazing it is and thinks, wow, that’s quite a greenhouse for $3,000. He doesn’t think to ask Joe anything else about it.

Once the $3,000 budget is exceeded at month three, Joe stops making payments on the greenhouse. Six months go by, and after much warning, the greenhouse company files a claim in court. Ultimately, it gets a judgment against Joe and John, as the court concludes they were operating the farm business as a partnership. As such, Joe was authorized to purchase the greenhouse on behalf of the partnership, and John’s assets are on the hook to cover the partnership’s debts. The court puts a lien on the farm property. But, the farm property is also owned by their sisters, who are not part of the farm operation. The court finds out about John’s mountain house and puts a lien on it to cover the debt. The court also garnishes a portion of John’s wages from the community college. As you might imagine, John is quite upset with Joe. While he could sue Joe, it’s not worth it because Joe doesn’t have any personal assets. So, he must suck it up and pay for his partner’s bad decision.

There are ways to get around these concerns

While these concerns are real, and every farm operation that is operating as a sole proprietorship or general partnership should be made aware of them, they shouldn’t be overstated. There are mechanisms to help protect the personal assets of owners that run sole proprietorships and general partnerships.

Insurance should be the first line of defense, even if you have a business entity such as an LLC or corporation. Second, many debts can be restructured or discharged through bankruptcy. This is not a solution; it’s simply a fact. It’s also worth noting that while other entities such as the LLC, C corporation and cooperative offer protection over the owners’ personal assets, it’s not absolute. If the owners do not uphold good business practices, such as properly capitalizing the entity, keeping personal assets separate from their business assets and keeping good accounting records, creditors can still go around the personal liability protection provided by the entity.