Question

John Henry has a small housecleaning business that currently is a sole proprietorship. The business has nine employees, annual sales of $480,000, total liabilities of $90,000, and total assets of $263,000. Including the business, Henry has a personal net worth of $467,000 and nonbusiness liabilities of $42,000, represented by a mortgage on his home. He would like to give one of his employees, Tori Kobayashi, an equity interest in the business. Henry is considering either the partnership form or the corporate form, where Kobayashi would be given some stock. Kobayashi has a personal net worth of $36,000.

a. What is the extent of Henry’s exposure under the sole proprietorship in the case of a large lawsuit (say, $600,000)?

b. What is his exposure under a partnership form? Do the partners share the risk?

c. What is his exposure under the corporate form?

Answer 1

1) If John is running Sole proprietorship then his exposure to the extent of personal liability.

Business exposure = Total Assets - Liabilities

= 2,63,000 - 90,000 = 1,73,000

Personal Assets = 4,67,000 - 42,000 = 4,25,000

Total Assets = 1,73,000 + 4,25,000 = 5,98,000

Maximum he can bear the risk of 5,98,000

2) If he enter into partnership then risks are share among all the partner. His employee personal net worth is also eligible for calculating the exposures. I.e. 36,000.

3) If John work under corporate form then exposure liability is limited to extend fund available with company.