How Does Your Startup Compare to Other Small Businesses?

How Does Your Startup Compare
To Other Small Businesses?

Mike Armour

What percentage of American businesses have no payroll? Would you guess 15%? Or 30%? How about 75%?

Surprising as it may be, that 75% figure is closest to the truth. About three out of every four businesses in the U.S. are operated solely by their owners. They have no salaried or hourly employees.

These businesses do not even pay their owners a salary. The owners derive their income directly from business profits.

And how many businesses fall into this category? According to the U. S. Census Bureau, something on the order of 21 million.

These statistics tell you that the U.S. is not a nation of small businesses. It's a nation of micro-businesses.

Even though these micro-businesses operate in the mainstream of American life, they live in the shadows of most economic reporting. Total receipts for companies with no employees account for just over three percent of the all business revenue in America. Many economic reports regard this percentage as so insignificant that they ignore micro-businesses altogether.

As a result, unless you’re willing to dig through mounds of data, you’re not going to have many points of comparison by which to contrast your own micro-business against the performance of others. So let me share some of my personal observations from touring the data.

1. Starting small is okay. Staying small is okay, too.

In our "bigger is better" culture, men and women who launch a startup sometimes feel a bit apologetic about the fact that their business is so small. But no apologies are needed. As the data above shows, even if you’re the only worker in your business, you’re still part of a huge universe.

Keep in mind that upwards of six million new businesses start each year (currently about 543,000 per month). According to a thorough study of survival rates by the Small Business Administration, 44% of them are still in business four years later.

Over a four year period, then, roughly 24 million businesses start and approximately 13.5 million close their doors. That’s an average net growth of about 2.6 million businesses per year.

Now, since these statistics include businesses of every size, the annual net gain in the number of small businesses is slightly less than 2.6 million. Yet there are 21 million businesses run solely by the owner, with no employees.

This means that the universe of micro-businesses is heavily populated with companies that have been around a decade or more and have never grown (from a staffing standpoint) beyond their startup size.

If your ambition is to build a company of fifty, a hundred, or five hundred employees, go for it! But if you choose to remain a micro-business forever, don’t feel a need to apologize or make excuses. You’re actually in the mainstream (numerically) of American small business.

2. If you’re operating as a sole proprietor, outside of an LLC or a corporate structure, you’re like most micro-businesses.

Is that a good thing? Or not so good? In most instances I’m inclined to believe that it’s not so good.

According to income tax filings, fewer than one in twenty owner-operated businesses are structured as a limited liability company (LLC). The balance operate with no liability protection from a legal standpoint.

And without liabiity protection the owner’s personal assets are unprotected if a disgruntled customer or vendor takes legal action against the business.

There are fundamentally two liability scenarios which every business owner faces. And each of these scenarios raises a specific legal question.

  • First is the situation in which a lien or judgment is levied against the owner for personal or private actions outside of the business. An example would be an owner who loses a lawsuit for causing an accident while on vacation. A situation like this raises the question, "Can the assets of the owner's company be seized to settle the lien or judgment?"
  • The second scenario involves a lien or judgment against the LLC itself, perhaps for breach of contract or an injury suffered by someone using the company's product. The question here is, "Can the owners personal assets be seized to settle the lien or judgment against the company?"

When an owner is a sole proprietor, acting without the protection of an LLC, the answer to both questions is, "Yes." There is no delineation between the owner's assets and those of the company. One purpose of an LLC is to create a legal line of demarcation which separates the owner's personal assets from the company's assets.

Now, how does the protection of an LLC play out in real life? In part, it depends on the jurisdiction in which you live. Let's take the first scenario, where the owner's personal and private actions outside of the company lead to a lien or judgment. If the company is an LLC, can its assets be seized or attached to satisfy this levy?

In some states the courts have answered in the affirmative. They hold that the assets of the LLC are no more protected from seizure or attachment than any of the owner’s other personal assets.

Because of these court rulings, you occasionally see articles, particularly on the web, arguing that it's pointless for a sole proprietorship to form an LLC. If the line of separation between the owner and the LLC can be penetrated so easily, these articles argue, what's the point of having an LLC?

But this line of reasoning ignores the fact that most states still consider the LLC shield sacrosanct. It also ignores the second scenario above, where the lien or judgment in question is levied against the company itself. If the company is an LLC, can the owner's personal assets be seized or attached to settle such claims against the company?

Here the courts have been less ambiguous. In general they have been prone to maintain the wall of separation between the assets of the LLC and the assets of the owner. Otherwise, if the company went into bakruptcy, creditors could seize the owner's household effects and personal bank accounts.

So while an LLC may not completely protect the company’s assets from liens or judgments incurred in the owner’s personal or private life, an LLC is likely to protect the owner’s personal and household assets if the company itself is the subject of a lien or judgment.

In today’s hyper-litigious society, where people seem to look constantly for reasons to sue, this one consideration alone makes forming an LLC a smart move. Especially when you consider how little it costs to create an LLC and how little paperwork is required to maintain it.

3. If you have serious financial aspirations for your business, a sole proprietorship without employees may not be the way to go.

Based on Census Bureau and IRS data the average annual income for non-farm sole proprietorships is strikingly low. The Census Bureau's most recent statistics put the average gross income for non-employer firms (those run entirely by the owner, with no employees) at $45,688.

According to the IRS, the average business receipts for all sole proprietorships (including those with employees) is about $58,000 per year. And their net income is just under $12,000.

The average net income for this group is dragged down significantly by the vast number of sole proprietorships which are a side-business or a source of supplemental income for a household. These owners — about two out of every three sole proprietors — are not pursuing their business fulltime.

But even if we disregard these part-time businesses, another statistic from the IRS cannot be ignored. In 2008, the latest year for which we have detailed statistics, only 10.7% of all sole proprietorships had receipts totallying $100,000 or more. This, in turn, points to a stubborn reality. Because sole proprietors cannot leverage off of the economic contribution of others in their organization, there is a severe cap on the earning potential of most businesses in this category.

Thus, if building a larger nest egg for retirement or to fund some dream is the purpose of your startup, getting to your goal will be very difficult if you operate long-term as a sole proprietor without employees. When you do so, you create no "multiplier effect" for your energy and effort.

Share This With Friends

Leave a Reply

Your email address will not be published. Required fields are marked *