Do I Need to form a Sole Proprietorship or an LLC?

Do I Need to form a Sole Proprietorship or an LLC

Until the end of the 1990s, sole proprietorships and corporations have been the most popular business structures. However, with the rise of limited liability companies in 1997, LLCs have made a strong business formation alternative to both of those structures in small-scale and large-scale businesses alike. Today, though, we are going to talk about LLC companies against sole proprietorships. With a whole lot of information and comparison guides available on the best LLC service websites, we’ve strived to create a quick yet informative overview on this topic to help you pinpoint specific features of these business forms and the differences between them.

A Sole Proprietorship: Pros and Cons

Sole proprietorships exist beyond business incorporation. What does it mean? It means business operates without being actually incorporated. Thus, if you provide some sort of services or sell some goods on your own, you are automatically considered a sole proprietor by state authorities. It’s by far the simplest and most common business form widely used by smaller entrepreneurs all across the US. As with any other business formation type, this structure has its own pluses and minuses.

Sole Proprietorship Pros:

  • There is nearly no paperwork to file with the state except for some specific licenses you might need to run your business in a certain industry. The same is true for annual filings. In other words, there will be almost no routine formalities to follow;
  • Super-simple management structure covering only the company owner. No added managers are involved, the owner is the only boss;
  • All business profits and losses are by default reported on the owner’s personal tax return. No tricky taxation schemes are applied;
  • Unlike other business incorporation types, sole proprietorships can benefit from the tax advantage of self-employment that allows minimizing expenses by deducting business-related costs from taxable amounts.

Sole Proprietorship Cons:

The main distinguishing feature of a sole proprietorship as a business formation type is that the company owner is not separated from the business. And sole proprietorship drawbacks are mainly related to this peculiarity.

  • In contrast to LLC companies and corporations, sole proprietorships bring no personal liability protection. As a result, you remain liable for all financial and legal liabilities of the company, and those liabilities might be secured by your personal assets if the need arises;
  • The lack of personal protection and owner-focused managing structure makes sole proprietorships unattractive for investors. So, raising capital for business growth will be an issue.;
  • For the same reasons we’ve already mentioned, sole proprietorships have lower credibility both with financial institutions and on the market overall. Hence, banks are not eager to provide business loans to sole proprietorships and market partners are less loyal to companies without a solid trade name.

LLC Formation: Pros and Cons

A limited liability company or an LLC company is a formal business structure normally established by several members. It got in full force in 1997 and still stands strong today. What sets this business form apart from all other structures is its hybrid nature. An LLC embraces the best features of both a sole proprietorship and a corporation, combining a straightforward managing framework with the legal protection benefit. This is what makes this type of business incorporation so popular now.

LLC Pros:

  • High credibility at all business levels since LLC formation gives your business a legal shape and creates a legal entity with its own rights and liabilities;
  • LLC companies offer reliable and consistent personal liability protection against financial and commercial business obligations as well as against lawsuits and business debts. In other words, you are separate from your company, and there will be no risk for your own assets to be used for settling the business indebtedness;
  • Though LLCs are also not much favored by investors, raising financing from the banks, crediting and financial organizations won’t be a problem;
  • LLC is one of the business formation types that enjoys the best taxation flexibility. Pass-through entities by default (similar to sole proprietorships), LLCs can choose to be taxed as corporations to optimize their tax expenses.

LLC Cons:

  • The establishment of a corporation and an LLC is a process that engages state-related paperwork and formal routines. You’ll have to file documents with the state both at the stage of business formation and at the stage of business maintenance. Those are formation docs, annual filings, business-specific licenses, and permits;
  • There are several added taxes to be paid at the state and local levels;
  • Business incorporation does entangle some costs that vary by state.

Sole Proprietorship and LLC Formation: Major Differences

To spot the major differences between sole proprietorships and an LLC, let’s see how they stack up in main business aspects:

  • Business formation: To establish a sole proprietorship, you need to do nearly nothing but get some licenses or permits specific to the industry or area. To start and run an LLC, you need to legalize your business entity first by filing the Articles of Organization with the state, and then some licenses might be needed as well, not to name the registered agent, EIN, and other formalities. Besides, the filing process engages state fees;
  • Taxes: Both sole proprietorships and LLC companies are pass-through entities with business profits and losses passing onto personal tax returns of the company owners. However, LLCs provide the privilege of being taxed as corporations, which might be beneficial in certain business situations;
  • Financing: Neither of these business formation types is a great choice for raising investors’ capital. However, LLCs are legal entities in the eyes of the banks while sole proprietorships are rather regarded as physical persons. Hence, LLCs receive business loans much easier;
  • Liability Protection: That’s the biggest difference between these two business incorporation forms and the biggest plus of an LLC. It’s a security shield for your personal assets against business debts and liabilities you won’t experience with a sole proprietorship.

Sole Proprietorship vs LLC Formation: What is the Right Choice for Me?

As with any question of this type, there is no single right answer. By and large, each business structure is a good choice for a certain business scenario or situation. While protections and benefits of LLC companies are hard to underestimate, sole proprietorships are still widely favored by small businesses, freelancers, and many service providers. However, as soon as your business starts to grow, it’s time to reconsider your business structure to get more flexibility and financial security. And if the formal part of the process looks a bit intimidating and unclear, there are multiple LLC formation services available on the market today that will handle all the formalities for you.

You May Also Like

About the Author: Michael Dunlop