Starting a business is an important step. There are several crucial decisions you have to make in order to realize your dreams and ambitions. One of them is choosing your business structure.
Every aspiring entrepreneur must decide on either starting a business as a sole proprietorship or forming a Limited Liability Company, and what the consequences may be.
In fact, this is a really big decision for your business, because it determines factors like:
Although both of these structures allow you to operate without partners or employees, the difference between them is significant.
Let’s talk about what an LLC and a sole proprietorship are, and compare the LLC vs. sole proprietorship. Also in this article, we will answer the question of whether the investment in the LLC pays off, and outline the advantages and disadvantages of both business structures.
A sole proprietorship is the easiest and cheapest way to do business.
If an individual or a married couple starts a business, they are considered to be a sole proprietorship by default in terms of legislation.
It is very easy to form one. Being an informal business structure, the state registration is not required. There are no mandatory state fees either. Actually, it is the easiest way to realize a dream of having your own business.
However, before making the final decision on running a business as a sole proprietorship, you should take into account all the features of this type of business. Here are some of them:
A sole proprietorship does not create a separate legal entity. The owner and the business are treated as one. Therefore, you can often distinguish a sole proprietorship from other forms by the fact that its name is the same as the owner’s name.
If you want to operate under a different name, you can apply for a DBA. This abbreviation stands for ” doing business as” and allows you to operate under a fictitious name.
An LLC is a separate legal entity founded by one or more members in accordance with state law.
Today, more and more people form an LLC to run a business. If you are thinking about this option, consider the features of an LLC such as:
You can distinguish an LLC from other forms by the special “designator” in the name, which are words such as “limited liability company” or the abbreviation “LLC”.
Both options have advantages and disadvantages. There is no definite answer to the question of what is better, a limited liability company or a sole proprietorship. It all depends on the unique needs of each particular business.
We have prepared a comparison of an LLC versus the sole proprietorship to better demonstrate the peculiarities of these two forms.
If we compare sole proprietorship vs LLC in terms of formation features, the first one has a significant advantage regarding its simplicity and cost.
There is no statutory registration procedure for the sole proprietorship, so you just have to get started.
However, the lack of formal requirements for starting a business does not mean that there are none at all. Keep in mind that depending on your business activities and location, you may need to obtain a license or permit. You can also apply for a DBA, if you plan to run your business under a fictitious name.
Forming an LLC requires more formalities. Depending on the state, the requirements for formal incorporation may vary, but the basic steps generally include the following:
The cost of the mandatory state fee depends on the state and ranges from $50 to $200.
With sole proprietorships, decision-making and management is performed directly by the owner of the business. This does not prevent him from hiring employees or other specialists, such as lawyers or accountants, but the owner is always at the head of the company.
The management structure of an LLC is determined by the number of its participants. Thus, a single-member LLC is managed by its owner. However, when it comes to a multi-member LLC, the difference between the sole proprietorship and an LLC is more obvious. There are two types of management available for such companies:
Voting procedures on the decision-making process and distribution of votes among the participants are usually established in the Operating Agreement.
Due to the fact that the sole proprietorship is not a separate business entity, you are not required to pay taxes on its behalf. In this case, it is the owner’s responsibility. The owner must indicate all profits and losses in the Form 1040, which is enclosed with the personal tax return, and pay income tax on that amount.
There is also a self-employment tax. All sole proprietorships must pay it on time to avoid IRS penalties.
If you want to choose a tax treatment on your own, when thinking about an LLC or a sole proprietorship, the first one is the best option. Unlike a sole proprietorship, a limited liability company can be taxed as:
When planning your expenses, it’s also important to keep in mind that income tax is not the only tax you have to pay. Depending on state requirements, both the LLC and sole proprietorship may be subject to:
When you choose the LLC or sole proprietorship for small business, the ability to protect your personal assets can be a strong argument.
Because sole proprietorships treat the business and the owner as one, their assets are not separated. The owner is fully liable for business debts and obligations, and, furthermore, risks personal assets.
Forming an LLC is one of the most reliable ways to secure your real estate, money, car and other personal assets from possible creditors. Since an LLC is a separate legal entity, it is responsible for its own debts. The owner’s property is untouchable.
There are some exceptions where the court may disregard the effect of limited liability, for example:
Due to the fact that a sole proprietorship is an informal business entity, it is not subject to compliance requirements.
For an LLC, there are different rules. You will need to provide:
Depending on the needs and structure, a sole proprietorship or an LLC must:
There is no best business structure that perfectly fits every entrepreneur. That’s the truth.
However, based on the difference between an LLC and a sole proprietorship, it is possible to choose the type of enterprise that will be right for you.
You can’ t deny that at the initial stage a sole proprietorship does provide some benefits. Because of the lack of formal requirements, you can start making deals without wasting time and money on registration.
This option would work well for your small business if it:
On the other hand, the ability to protect personal assets, flexible taxation, and the credibility that an LLC provides cannot be overstated. Choose this legal structure if:
Many aspiring entrepreneurs choose the form of their future company without having enough information about each of the available options. If you are not sure yet, or if you have any questions, a consultation with a professional can be very helpful. An experienced lawyer or accountant, who understands state law, will answer all your questions.
According to general rule, a sole proprietorship operates a business under the name of its owner. Registration is not required in this case.
However, if you plan to operate under a different name, you must apply to the state for a DBA.
The LLC name is automatically registered and assigned to the company upon approval of its Articles of Organization.
In case you are not ready to officially launch yet, but you want to reserve a certain variant of the name, you can apply for a reservation. This will protect your name from third parties for a certain period of time to give you time to complete preparations for company registration.