Widely maintained across the US, small businesses are booming now. And on the verge of opening a small private firm or initiating a promising startup project, many entrepreneurs wonder about which legal structure to choose for their enterprise.
A sole proprietorship or LLC? Which entrepreneurial model will best suit your entrepreneurial needs and plans? Let’s try to figure it out together.
Table of Content
It is an unincorporated business form or disregarded entity that requires no state registration. Unless you establish a formal legal entity, you’ll be automatically considered a sole proprietor once you get into entrepreneurial activities.
This informal entity is owned and operated by a single individual. Directly associated with its enterprise, the owner is held liable for all business commitments and indebtednesses.
To understand what this business form offers in practice and how it performs, take a look at its major fortes and drawbacks.
|Simplicity||No personal asset protection|
|Straightforward management||Lack of tax benefits|
|No profit distribution requirements||No investment potential|
|No-frills taxation||Restricted growth opportunities|
|Self-employment benefit||Low credibility|
A limited liability company (LLC) is an incorporated entity that requires state filing. It can be owned by a single individual or multiple co-owners called company members.
Once filed with the state, an LLC becomes an independent legal person with its own rights, authorities, duties, and commitments. As such, the company is legally separated from its members. And the entity and member assets are split up.
LLCs legally protect their owners from financial and regulatory liabilities of the enterprise. Likewise, an LLC structure holds stockholders non-liable for the actions of the company employees if there are any.
What makes LLCs so popular? And where do they lag? LLC pros and cons enlisted side by side will demonstrate the strong and weak points of this business model you should be aware of.
|Liability shield||Legalities to observe|
|Flexible management||Higher running costs|
|Consistent enterprise growth|
When comparing these two business forms to decide which one is better for your business situation, you should take into account the following key factors:
To establish an LLC, you’ll have to prepare an LLC statute and file it with the Secretary of State. LLCs are state-specific entities and registration requirements vary by jurisdiction.
Besides, there are certain state rules you’ll have to observe afterward to keep your entity compliant and legitimate.
By way of contrast, there are no formalities to match opening a sole proprietorship unless you plan to run it under a DBA (doing business as) name that requires state registration.
There is a compulsory filing fee you should pay to the state to form an LLC. The rate varies by jurisdiction and ranges from $40 in Kentucky to $500 in Massachusetts.
Further on, you’ll have to add an annual reporting fee ($100 - $200 on average) to your running costs to maintain your LLC in good standing with the state.
Meanwhile, sole proprietorships are free from those expenses.
Sole proprietorships use pass-through taxation and pay taxes on business profits on individual tax reports of their owners under their personal tax rates.
LLCs, on the other hand, are entitled to be taxed as:
This is by far the biggest difference between the two entrepreneurial models since an LLC safeguards your personal funds and property from company commitments.
And for sole proprietorships, business and owner assets are considered to be the same in the eyes of the law.
The fact of state registration alone gives LLCs more customer trust from the start. Legal entities also feel more reliable to creditors, sponsors, vendors, and suppliers and are overall more competitive on the market.
Being the simplest organizational model, this entrepreneurial form is a great choice for the following businesses:
An LLC structure has a lot going for it, so no wonder it’s on the rise. Consider opening an LLC over a sole proprietorship if:
Many startuppers and businessmen-to-be still choose a sole proprietorship structure for its simplicity and no-frills formation and maintenance. At the same time, though, our recommendation is to launch your business with an LLC.
With a formal legal structure in place, you‘ll protect yourself from business risks from the start and get a solid base for future business growth and expansion.