Managing the Legal Risks of a Coaching Business – Sole Proprietorship vs LLC

From incorporating to filing taxes, this article will help coaches navigate some of the less exciting, but very important aspects of running a business.

So you are excited to make a difference in people’s lives, and maybe you have even started coaching a person or two. Whether you are doing so pro-bono or have already starting charging for your valuable services, it is important to be aware of the legal responsibilities that come with running a coaching business. That’s right, coaching, just like any professional practice is considered a business. It comes with a set of legal responsibilities and risks.

  • What happens if someone refuses to pay, or worse, requests a refund?
  • Can you accept checks written to your business name?
  • What is someone decides to sue you?

In this article we will try to answer some of these questions. We will share some useful tips and link to resources that will hopefully help you navigate the legalities of operating a coaching business with ease.

DISCLAIMER: does not provide legal advice, and this article is not a prescription of what you should do. Please double check any information you read here and remember that you are responsible for your actions as a business owner.

The Legal Risks of Operating any a Coaching Business

In the United States, it is relatively cheap and easy to file a small claims suit against another person, or a business. For this reason, no one is exempt from the risk of being summoned to court by someone who believes they are entitled to repayment for damages incurred. In fact, one time a neighbor of mine filed a case against me, claiming that I had thrown a bone into his property, that his 3 fierce dogs would have fought over. Although his claims were false and I did not have to pay for his emergency veterinary bills, this nonetheless cost me a lot of stress and time. In the process I learned a lot about our legal system, starting with this first lesson: everyone is at risk of being sued.

Running a business however, and in particular one that encourages people to face emotions they fear, comes with additional risk and increases the probability that someone might get upset and choose to file an action. By accepting their money (and hopefully signing a contract as we will discuss later), you are putting yourself at risk of them requesting a refund. If you make promises of them obtaining specific results, in particular tangible ones that can be measure, the risk increases. Although it is most often possible to handle difficult situations by being cordial, professional and delivering refunds when requested, we recommend making use of legal entities and contracts to protect from worst case scenarios. The reason we stress this is because worst case scenarios are not simply refund requests. As explained earlier, a very disgruntled person may choose to identify you as the single source of their pain, and reparations can go far beyond the value of the services they paid you for.

For example, imagine you offer relationship coaching and posted on social media a claim that you can “help any couple avoid divorce by identifying the underlying causes of conflicts in marriage”. Now let’s say that a person hires you and goes through a difficult divorce nonetheless, causing them to lose personal assets of over a million dollars. What if, after the divorce, they choose to continue their legal journey and turn their efforts against you, claiming that you failed to deliver on your advertised promise, thus attempting to make you responsible for their financial loss?

Obviously, this example is somewhat far-fetched, but there are some rather incredible lawsuits in the news if you look closely.

Below we will discuss the first step you can take to reduce the legal risk of running a coaching business, namely forming a legal entity.

Forming a Legal Business – Sole Proprietorship vs LLC vs Corporation

Any of these three business entity types will set your practice’s official status as a registered, legal business in your state. This is a necessary step if you want to open a business bank account and accept checks or credit card payments in your business name. If you don’t form a business at all, you can only accept payment to your personal, legal name and that is what will appear on the bank and credit card statements of your clients. Beyond that first benefit, there are major differences between these entity types, in particular in terms of the difficulty of forming and operating them, and in terms of the legal separation (and protection) it creates for your personal finances.

Sole Proprietor: You are the business

For many years, I operated my web design and development practice as a sole proprietor, Doing Business As (DBA) Adal Design. Even in California where paperwork tends to be more involved, all I had to do was walk into the city hall of San Francisco where I resided, and pay about $100 to declare the business and publish its existence in a newspaper to make it official. It was easy and fast: within a few weeks I was able to open a business bank account with US Bank and start accepting checks written out to Adal Design. It felt official, and technically it was.

When it came to taxes, once again it was childishly simple. I used a basic cloud accounting solution like FreshBooks, which connected to my business bank account, business credit card and Paypal account. It would auto-categorize most of my transactions. This way, when it came time to file taxes, I already had real numbers handy for my sales and business expenses. I could then enter those numbers into TurboTax and be done within a couple hours!

The reason that forming, operating and declaring taxes as a sole proprietor is so easy is because there really isn’t much more to it than having an official business name, known as a DBA (Doing Business As). Technically there is no separation between the individual, the sole proprietor, and the business. The business income is your income. The legal responsibilities, are your responsibilities.

In short, a sole proprietorship isn’t much of a legal business at all, and if anything goes wrong, your assets and personal legal status is directly affected. In our example from above, if the disgruntled divorcee succeeds at convincing the judge that his losses were your fault, it is your personal assets that are at risk of being seized to pay the reparations.

LLC: A limited LIability Company

The title says it all. With an LLC, your personal liability is limited because it is technically the company that takes the blame, as long as an action is filed regarding losses and reparations related to business activity performed in the name of the company. So in the example from above, as long as a contract was signed defining the relationship between your client and the company, it is the company that will be summoned to court, not you. If you lose the case, technically it is your company that loses the case. This means that the judge can rule to seize and liquidate only the money and assets owned by the company to pay for the damages. Although that could mean the bankruptcy of your coaching business, this is far preferable to your personal bankruptcy. In some special cases, there can be what is called a “piercing of the corporate veil” where a judge can rule that you are personally responsible despite the protection from your LLC, but these cases are the exception, not the rule. Overall, an LLC, similarly to a corporation, should provide you with a good amount of legal protection by separating you from your business.

Although a little more effort than for a sole proprietorship (which isn’t saying much), forming an LLC is relatively easy. There are many online services that facilitate the process of filing for the entity with your state. Those sites allow to check whether your business name is available and then ask you a series of questions which are used to fill in the paperwork on their end. At LLC we used Rocket Lawyer and for under a couple hundred dollars and an hour or so, it was done! They also have a membership program that allows you to ask questions to attorneys, draft legal documents and even get contracts signed by your clients or contractors you might hire. Overall we are very pleased with this surprisingly affordable service.

A final benefit of forming an LLC is that you can easily do “pass-through” accounting. In short, this means that if you are self-employed when you declare your taxes, it is similarly simple to the sole proprietorship: your sales, expenses and personal finances are all declared together. This is by far the easiest way to declare taxes, as you don’t have to do anything complicated like paying yourself a salary… as you would with a corporation.

Do keep in mind that in some states, such as California, having an LLC costs about $800 in legal fees per year. However, this is a small price to pay to protect and separate your personal liability from the company’s. Since there are also no specific operational requirements for LLC owners, the Limited Liability Company is possibly the best choice for coaches who work alone, or as a small partnership or team.

Going Corporate: you’d better hire an attorney

Given the complications that come with running corporations, even major companies like Google started out as LLC’s. Although corporations can be easily formed using a service like Rocket Lawyer and provide similar legal protection to an LLC, they differ mainly in a few ways:

  • Corporations are ideal for companies that wish to go publick and sell stock to raise money.
  • Corporations can be owned by foreign entities making them ideal if you plan to seek international investors.
  • Corporations are complicated to operate, and failure to comply with the complex set of rules and procedures can result in penalties and even the forced termination of company.

One final piece of information is that there are two types of corporations. S-Corps still provide the option of declaring simpler taxes by electing to operate with “pass through” finances. C-Corps are better for companies that plan on seeking international investors and they will result in you being taxed twice: once for sales and once for the salary you pay yourself.

Overall, unless you plan on seeking investors, going international or selling stock on the public market, our preference is to steer clear of the complexities of operating a full-blown corporation.

Day to Day: Operating Your Business

Assuming that you made it this far and have declared your business as a legal company, here are some next steps that should help you operate smoothly and sleep well at night, knowing that your t’s are crossed.

Banking and billing: Income and Expenses

Keeping your personal and business finances separate is key to a successful tax declaration at the end of the year.

Regardless of which entity type you choose, you should now have an official business name. With this you can open a business checking (and savings) account at your bank. It’s also a great idea to have a business Paypal account. This way you can accept checks, Paypal and credit card payments. All of the payments should go straight into your business checking account. You should always transfer some of that money to a personal checking account before spending it on anything that is not a business expense. This will allow you to easily identify all of the business income coming from your client’s payments, commonly known as “sales”.

It is also a good idea to get a credit card that is specific to your business and always carry it in your wallet. When you buy office supplies, like a fancy pen to impress your clients, be sure to use that card. If you travel to meet up with a client or go to a networking event, write down where you were going and how many miles it was. Following these easy tips will keep all of your business expenses separate and allow you to easily tally them up at the end of the year for taxes. This is extremely important because as a business owner, you can deduct all business expenses from your gross income. You will only pay taxes on the resulting number, which is your net income.

Always sign contracts: Keeping things clear

Another important business lesson I learned over the years is to always write up clear expectations into a contract and have every single client sign one. A simple contractor’s agreement should state what services will be provided, when they will be provided and what the compensation and payment terms will be. These contracts also help to define what your client’s are not expect. In our example from above, a simple clause stating that you don’t take responsibility for the final and financial outcome of their relationship or separation would come in very handy!

Disclaimer: simply typing up statements in your own words won’t necessarily hold in court (and even attorney-written text isn’t guaranteed to either). It is always best to hire an attorney or use an online service to draft your contracts. However, don’t underestimate the psychological effect of including a clause in a contract. If it takes a particularly aggressive person to sue at all, it takes an more rare personality to file for a lawsuit requesting payments for something that is clearly protected against in a contract they signed!

A service like Rocket Lawyer comes in really handy here again, as you will be able to get help drafting a contract that works for you. You will then also be able to use their service to request digital signature of that contract and then store it online.

Don’t make the mistake of poorly drafting loose contracts that don’t protect you properly. I have witness my father lose thousands of dollars and countless nights of sleep when he nearly lost his contractor’s license over a claim that should have been protected against in his contract, after painting a client’s house and agreeing to fix something that went beyond their scope.

Wrapping Up

We sure covered a lot in this long article! Kudos to you if you made it this far. I hope that all of this “non-legal” and accounting advice helps you operate a sound business.

To conclude, I would love to invite you to share: what extra steps do you take to make your coaching business official and to protect yourself legally from worst-case scenarios?


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