When starting a business, choosing which business structure is right for you can be overwhelming. The five core legal businesses structures are sole proprietorships, LLCs, partnerships, corporations. For some, the choice is obvious, others need to put more thought into the pros and cons of each structure to choose one that suits their business best. To help you make a decision, we’ll be breaking down some of the key differences between a sole proprietorship and an LLC.
What is a sole proprietorship?
A sole proprietorship is commonly known to be the simplest and most common structure. A sole proprietorship is run and owned by one, and only one, person, and there is no distinction between the sole proprietor and their business. This means that the owner is entitled to all profits, but it is also solely responsible for all debts, losses, and liabilities incurred by the business.
A sole proprietorship is automatically formed if you are a business owner who is undergoing business activities, you don’t have to formally apply for this type of business status. Many people have a sole proprietorship without even realizing it. Freelancers are a prime example of sole proprietorships. That being said, there are still permits and licenses required for businesses, and sole proprietorships are no exception. The requirements needed vary depending on the sole proprietor’s location and the industry their business falls under.
Because a sole proprietor assumes all responsibilities for their business, and the business is the same entity as the owner, taxes are not filed separately. You must pay all taxes associated with your business, as the sole proprietor’s income is your business income.
What is an LLC?
LLC stands for limited liability company and is a separate legal entity that can be formed by business owners to operate their business. The key to LLCs lies in the “limited liability”, this type of company provides the same limited liability as a corporation but is much cheaper to operate.
This type of business structure offers personal liability protection for the business owner or owners, but taxation that is more similar to sole proprietorships or partnerships. An LLC is one of the simplest structures to ensure that your assets are protected in the event that your business is taken to court. LLCs can also have more than one owner, and multiple owners are known as members.
LLCs can be formed for almost any type of business, but some states require professionals with certain specialties to operate a special professional LLC. They can also be used to own commercial property under a single legal entity.
What are the advantages of a sole proprietorship?
The main advantage of a sole proprietorship is that they’re very straightforward and cheap to form. The most legal costs you’ll have to pay will be for any licenses or permits that you need to operate your business. You’ll also have complete control over everything to do with your business. Taxes are much simpler as a sole proprietor because you don’t have to file separate taxes, and the tax rates are the lowest out of any business structure.
On the other hand, since there is no separation between the business owner and the business itself you are much more vulnerable to liability as a sole proprietor. If you have any employees, this risk includes them. It’s also harder to raise money when you have a sole proprietorship, as you can’t sell any stocks, which limits your ability to attract investors. Banks may also be very wary of lending to sole proprietors because of the liability risks.
What are the advantages of an LLC?
The biggest advantage of an LLC is that the owner or owners have protection from liability. You can’t be held personally responsible for any debts that the business incurs, because the business is its own legal entity. This also protects you from any lawsuits brought against your business. LLCs provide their owners with pass-through taxation, which means that profits “pass-through” to the LLC owner’s personal tax return. This means that profits from the business can be taxed at personal tax rates, unlike a corporation.
Outside a sole proprietorship, LLCs are also the most straightforward business structure to set up and operate. You don’t need to have any directors or officers, and setting up the company is manageable for most people to do alone. LLCs also allow for more than one owner, so youcan share the responsibilities of the company. There isn’t any limit to the number of members an LLC can have, either, making them a more flexible option for ownership.
Even just having the title of LLC can be beneficial for a business. It helps to give a company credibility, provides an official business name, and makes it easier to get financial backing from banks and investors.
That being said, setting up an LLC is more expensive than a sole proprietorship or a partnership. LLCs also do have some limitations for investment, as most venture capitalists prefer to deal with corporations where they can gain stocks for their investments.
Should you start a sole proprietorship or an LLC?
At the end of the day the decision to operate as an LLC or sole proprietorship is your choice to make. For the most part, sole proprietorships are perfectly adequate for freelancers or those who don’t have any employees or aren’t concerned about liability. However, many people prefer the comfort associated with an LLC, as they know they are protected. If your business starts to expand to a point where the costs associated with setting up an LLC will be worth the benefits, it’s certainly worth some consideration. It’s also a highly recommended option if you are starting a business that will involve others.
It’s best to do your research and consider your own business structure and the benefits of a sole proprietorship vs. an LLC for your own business.
Frequently Asked Questions
Is a single-member LLC the same as a sole proprietorship?
No, a single-member LLC is still a limited liability corporation. The business and the business owner are separate entities. With a sole proprietorship, the business owner and the business are one and the same and take on the same income, debt, and liability.
When should a sole proprietor become an LLC?
Most people who run a business as a sole proprietor eventually consider forming an LLC. It’s a much safer option, as it limits your personal legal liability. If your business starts to generate significant income, or you have any concerns at all about instances of liability, it’s best to consider forming an LLC instead of continuing with a sole proprietorship. Many business owners choose to form an LLC when their business has earned enough income to make the costs associated with forming an LLC worth the benefits and protection. If you hire employees, you should consider forming an LLC, as any liabilities incurred by them will fall on you if you have a sole proprietorship.
Is it better to be self-employed or own an LLC?
Self-employed individuals are automatically considered to have a sole proprietorship. No official application is needed to be a sole proprietor. However, self-employed individuals can also form an LLC if they wish to create a single legal entity that operates their business and assumes liability.
Does a sole proprietor need an LLC?
A sole proprietor does not need to form an LLC, but they should consider it in cases where they wish to avoid personal liability for business proceedings.