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As if personal liability was not bad enough, there are several other disadvantages to using a sole proprietorship:

• Owners. There can only be one owner of a sole proprietorship. If you later want to bring on owners you will have to switch to another business entity.

• Sale. It is hard to sell a sole proprietorship since its value is based on the owner and not the business.

• Death. When a sole proprietor dies, the sole proprietorship terminates. The sole proprietor’s successors can only sell assets, not the business as a going concern.

• Audit Risk. Because sole proprietors report their business profits and losses to the IRS on Schedule C, there is a much higher risk of IRS audit. Schedule C returns are audited at a five times greater rate than corporate tax returns.

A general partnership is also a bad entity. In fact it is twice as bad as a sole proprietorship because you have twice the personal exposure: personal liability for your acts and your partners’ acts. This will be illustrated in Case No. 2 ahead.

Whenever two or more persons agree to share profits and losses a partnership has been formed. Even if you never sign a partnership agreement, state law provides that under such circumstances you have formed a general partnership.

A written partnership agreement is not required by law. A handshake is acceptable for formation. In the event you do not sign a formal document, you will be subject to your state’s applicable partnership law. This may not be to your advantage, since such general rules rarely satisfy specific situations. As an example, most states provide that profits and losses are to be divided equally among the partners. If your oral understanding is that you are to receive 75 percent of the profits, state law and your handshake will not help you. Instead, against your wishes, state law may have you sharing 50-50. You are better advised to prepare a written agreement addressing your rights and rewards. But again, you are better off not using a general partnership in the first place.

Unlike a sole proprietorship, in which only one individual may participate, by definition, a general partnership must consist of two or more people. You cannot have a one-person partnership. On the other hand, you may have as many partners as you want in a general partnership. This may sound like a blessing but it is actually a curse.

The greatest drawback of a general partnership is that each partner is liable for the debts and obligations incurred by all the other general partners. While you may trust the one general partner you have not to improperly obligate the partnership, the more general partners you bring aboard the greater risk you run that someone will create serious problems.

And remember, just as with a sole proprietorship, your personal assets are at risk in a general partnership. Your house and your life savings can be lost through the actions of your partner. While you may have had nothing to do with the decision that was made and you may have been five thousand miles away when it was made and you may have voiced your opposition to it when you found out it was made, you are still personally responsible for it as a general partner.

As such, a general partnership is much riskier than a sole proprietorship. In a sole proprietorship, only the proprietor can bind the business. In a general partnership, any general partner—no matter how wise or, unfortunately, how ignorant—may obligate the business. By contrast, limited liability companies, limited partnerships, and corporations offer much greater protection. All of them offer owners limited personal liability for business debts and the acts of others.

It should be noted that because of these unlimited risks the last thing you want to do is become a general partner of an enterprise in which you do not have day-to-day management control. If you do not thoroughly know what is going on in the company you should not put your future on the line as a general partner.