LLC vs. Sole Proprietor: Determining Your Business Structure
Whether you’re just starting a business or have had it up and running for a while, there’s no shortage of decisions to make on a daily basis. One of the most important ones you’ll make is how you decide to structure your business legally, which can affect things like taxes and access to business funding.
If you’re solo, you may start out as either a sole proprietor or a limited liability company (LLC). You can also switch later on to an LLC or a corporation. Both forms of business have advantages and disadvantages, so which is best depends on your personal and business circumstances. To sort it all out in detail, it’s worth engaging the services of your accountant or attorney.
But in the meantime, nolo.com says you can learn some basics about these structures and begin to assess the pros and cons for your own situation. Here are some considerations:
- Ease and cost of formation: Sole proprietorships are the most popular in the U.S. because they’re the easiest and least expensive and require the least amount of paperwork. LLCs, on the other hand, require state registration, articles of organization and a filing fee—in other words, more time, money and effort upfront.
- Raising startup capital. Either way, it’s tough to get started. With an LLC, you have the advantage of pooling your resources with other owners; getting a loan or line of credit could be more feasible with the guarantees of multiple owners. If you’re a sole proprietor, you’re on your own.
- Taxes. The differences in how your business is taxed depends, in part, on whether your LLC qualifies as a partnership or S corporation. Definitely consult a tax professional.
- Your role in the business. How much control do you want? You may want to stay a sole proprietor or single-member LLC. With multiple owners, though, be sure to have an operating agreement that spells out roles and expectations.
- Personal liability. If you’re a sole proprietor, you are the business, and you’re responsible for everything related to it. Which means your personal assets could be at risk. Setting up an LLC establishes your business as a separate legal entity, which generally limits your personal risk but may not eliminate it altogether.
The popular website legalzoom.com spells out some of the advantages and disadvantages of LLCs as compared with sole proprietorships and partnerships. According to the site, LLCs have several distinct advantages over the other two business forms:
- Easier to raise capital. LLCs have a variety of avenues open to raising capital, including admitting new members. Plus, the site stresses, lenders typically look more favorably on LLCs, whose owners are not personally liable for business debts. This is an important consideration, because although you may not need funding now, that can (and probably will) change as your business grows.
- Owners not personally responsible for company debts (see above).
- Ease of ownership transfer. LLC ownership interests can generally be sold to third parties without disrupting operations. Not so with other business forms.
However, where there are advantages, there are also disadvantages of LLCs as compared with other structures. Legalzoom.com lists several, including:
- Cost to set up.
- A more formal organization, including more paperwork.
- Separate records (and funds), which means business and personal can never be mingled.
Since so many businesses operate online, are the LLC vs. sole proprietor issues any different? Smallbusiness.chron.com addresses this for online retail businesses specifically. Although the considerations are largely the same, the site does raise a couple of additional factors:
- LLC behind your name adds credibility and a sense of security for customers.
- LLC adds protection for your business name once registered with the state.
Finally, if you’ve been operating as a sole proprietor for a time, how do you know if it’s time to convert to an LLC or even a corporation? Legalzoom.com provides insights on deciding to convert or not, but in the end offers this to business owners:
Ultimately there is no single solution that works for every type of business. Whether it is best to incorporate or form an LLC depends on the type of business you have, the owners, and your financial and business growth goals. Consider all the variables and choose the entity type that will be most to your advantage.
Image courtesy of Jeroen van Oostrom/ FreeDigitalPhotos.net