Sole proprietorship vs LLC: A Comprehensive Breakdown
Starting a new business? Congratulations! You’re probably wrapped up in all kinds of to-do’s to get your company up and running. And since you’re here,one of those to-do’s is probably whether you should register your company as a sole proprietorship vs. LLC.
There’s no straight answer to this question, as it depends on each unique business and business owner’s situation, needs, and goals. In this article, we’ll look at what a sole proprietorship and an LLC really are, their pros and cons, and the key differences for you to consider as you decide which one is right for you.
What is a sole proprietorship?
A sole proprietorship is the simplest type of business structure. In a sole proprietorship, there’s no legal separation between a business owner and their business entity. Essentially, you act as an extension of your company.
This business structure is the least complicated to set up and manage, so it may be best for small businesses that are just starting out. But, like any new endeavor, it’s important that you weigh out the advantages and disadvantages before you make your decision.
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Advantages of sole proprietorship
Let’s look at some of the top perks of a sole proprietorship.
It’s simple. There isn’t actually any work required to establish a sole proprietorship. If you’ve received business income for anything you’ve done on your own, whether that’s selling a product or providing a service to a client, you’re automatically considered a sole proprietor.
There’s less legal red tape. Because you’re automatically a sole proprietorship when you do business on your own, you won’t need to file any complicated paperwork or follow any legal guidelines.
Taxes are easier. Since they’re operating as an unincorporated business, sole proprietors will only file a personal tax return. This means you don’t have to worry about filing multiple tax documents, or filing out complex or complicated forms. This may be the same for a single-member LLC, but if there are multiple owners, you’ll need to look into things like a partnership tax return.
Disadvantages of sole proprietorship
And now for the drawbacks.
More risk from personal liability. In an LLC, you’re separate from your business entity. This means that if you find yourself in a lawsuit for business debts or other problems, it’s less likely that someone can come for your personal assets like your money or property. But in a sole proprietorship, you don’t have personal liability protection—meaning you could lose it all in a worst case scenario.
You’re on your own. Running a business alone can be tough, especially when you don’t have partners or investors. This is one reason that business owners opt for another business structure or setup.
Trouble getting funding. Generally speaking, a sole proprietorship is viewed as less “official” and therefore less credible in the eyes of investors, banks, and other partners who can provide business loans or funding.
What is an LLC?
An LLC, which stands for limited liability company, is a business structure category that mixes elements of a sole proprietorship and a corporation. There are many types, each with its own set of rules and considerations.
We’re going to focus on a single-member LLC, which is the closest to a sole proprietorship. In this type of LLC, there’s one person who owns 100% of the company (that’s you).
Advantages of LLCs
Here are some LLC perks.
You have personal liability protection. While you’re not 100% protected in every single scenario, an LLC will give you a base level of liability protection. This means that your business is separate from your, so you’re less likely to lose your personal assets like money or property if your business gets sued.
Flexibility with your taxes. As a single-member LLC, you have a choice in how to pay taxes. You can be taxed as a sole proprietor and file a personal tax return, or you can file as an S corporation or C corporation. Many choose to file as a corporation for “pass-through” tax benefits, meaning that business income “passes through” to the personal tax returns of owners and shareholders.
Less setup than other business types. Single-member LLCs require some paperwork to set up, but it’s simpler than other types of business structures like multi-member LLCs or corporations. After you file your articles of corporation with the state, the paperwork is done.
Disadvantages of LLCs
And here are some LLC drawbacks.
Higher costs. You’ll have to pay some fees as an LLC, which might include a state filing fee, registered agent fee, and state annual report fee. These could total several hundred dollars or more per year.
More bureaucracy. There are more rules and regulations and more paperwork. You’ll need to regularly deal with entities like federal and state governments and possibly more, depending on the nature of your business.
Sole proprietorship vs. LLCs: The key differences
Starting a sole proprietorship usually costs less than an LLC because there’s no need for formal paperwork. Some sole proprietors might choose to register a doing business as (DBA) name, and the cost for this varies by location.
For an LLC, the setup cost depends on the business location since each state has its own requirements. For example, many states require the LLC owner to register a unique name with the secretary of state. The US Small Business Administration mentions that this registration generally costs less than $300, but the exact amount can vary depending on the location and type of business.
Liability is one of the main reasons that any business owner opts for a limited liability company over a sole proprietorship. That’s because limited liability companies offer more protection to business owners, as their business is a separate legal entity from them.
With an LLC, the personal assets of a business owner are more protected. Say for example that you’ve taken out a business loan that you can’t repay. Because your personal assets are separated from your business assets, you’re less likely to lose any of your personal assets if your lender takes legal action against your business.
Whereas with a sole proprietorship, you might be at risk to lose your personal assets because you don’t have that personal liability protection.
When raising capital, LLCs often have an advantage over sole proprietorships. Investors typically view an LLC as more secure because it’s a distinct business entity. This perspective is consistent among investors, as well as for business loans and lines of credit.
Banks also favor LLCs, providing them with business loans. In contrast, they might only offer personal loans to sole proprietorship owners, which have more limits. Moreover, an LLC can invite more partners to invest, while a sole proprietorship remains a one-person show.
When you run a sole proprietorship, your personal assets can be in danger if your business owes money, especially if you’ve made big investments.
In contrast, an LLC owner bears responsibility for the amount they’ve invested in the business. If the business experiences financial issues, the owner’s personal assets remain protected. Still, it’s vital to keep business and personal transactions separate. Always talk to a tax adviser for guidance.
Comparing the two, an LLC provides stronger protection for personal assets than a sole proprietorship. This protection is a prime reason many choose the LLC route.
Management and control
In a sole proprietorship, one person shoulders all business operations and management tasks. This means the owner enjoys full control. However, this also might curb the business’s growth potential, placing a substantial weight on a single individual.
On the other hand, LLCs offer greater management flexibility. A single-member LLC can function much like a sole proprietorship, but there’s also the choice to add more members or hire employees. While the owner retains primary control, they must consider the preferences and requirements of other participants.
Time to start your business
Registering your business is a strategic move: you’ll be able to take advantage of certain things like tax considerations and have the ability to control your image to future partners and customers. Ultimately, the decision is yours to make—what do you envision for your brand, and will an LLC or sole proprietorship be the best fit for that vision? If you’re still on the fence, consider consulting a lawyer or tax professional for their sage advice and tips.
Sole proprietorship vs. LLC FAQ
Why is a company better than sole proprietorship?
In a sole proprietorship, one person makes all the decisions and faces all the risks. A company, on the other hand, can have investors. These investors provide funds and aren’t liable for the company’s debts. This benefit often makes companies a preferred choice for many.
What is the biggest difference between a sole proprietorship and LLC?
Liability. LLCs offer enhanced protection against personal risks.
Funding. An LLC typically finds it easier to obtain external finance than a sole proprietorship.
Taxes. The tax structure of a one-member LLC can change based on specific circumstances.
Costs. Setting up a sole proprietorship is free, whereas LLCs have registration and ongoing expenses.
Management and control. Sole proprietorships grant more control than LLCs.
When should a sole proprietor become an LLC?
A sole proprietor should think about becoming an LLC for two main reasons. First, if they plan to bring in more owners. Second, to protect their personal assets from legal and financial issues. Given these points, moving to an LLC can be a wise step for many entrepreneurs.