To save you the time of reading this whole article, we can break it all down in one sentence:
Sole Proprietorships offer ease of setup at the cost of liability protection whereas LLCs offer liability protection and tax options at the cost of having to go through your state’s registration process.
Kind of a run-on sentence, but a sentence nonetheless.
Continue reading for a deeper look into the costs and benefits of these businesses.
Sole Proprietorships vs Limited Liability Companies
In your search for financial independence, you realize you need to start making moves. Your first step in this case is starting a business.
With so many options, the question becomes:
Which one will be the best for you?
If you plan on being the only owner of your business then you have two options:
Single-Member LLC (Limited Liability Company)
You can think of it like this:
Sole Proprietorships are for side-hustles and LLCs are for full-on operations. This is just a generalization and, like most things, there are many exceptions.
These are two of the most popular business entities among professionals and novices alike.
Today, there are millions of LLCs and Sole Proprietorships operating across America.
The Sole Proprietorship is simpler to set up. You don’t get any protection but you will have more direct control over your business’s operation.
On the other hand, you have the Limited Liability Company. An LLC gives you personal property protection in the event lawyers or banks come after any money your business owes. This requires you to register your LLC your state.
The business model you decide will impact your business’s initial success. If your business isn’t started off on the right foot, it makes continuing operations more difficult.
The beginning is critical.
It cannot grow if it is not properly rooted.
By the end of this article, you will understand the details of each of these business structures so that you can make your own informed decision.
Keep reading to find out how Sole Proprietorships compare to LLCs.
Any information provided by “Business Initiative” is not meant to be taken as legal or financial advice. We highly recommend that you speak with lawyers, financial advisors, and tax professionals before making any binding decisions when it comes to starting, operating, and growing your business.
What is an LLC?
LLC is commonly misunderstood to stand for Limited Liability Corporation. In reality, it stands for Limited Liability Company.
LLCs are great for scaling and expanding your operations.
With an LLC you can:
Take on more risk (loans)
Upgrade your tax status to your benefit.
Even open a business bank account
The Limited Liability Company is great for novice and advanced entrepreneurs alike.
LLCs are some of the most versatile entities. They can be tailored to fit your business goals to get you where you want to be.
You choose how many Owners or Members, as they’re sometimes called, you want to run the business with.
These can be people or they can be other entities altogether, so long as one of the Members is a person.
You also have a say in how your business pays its taxes.
By default, LLC Owners pay taxes through the Pass-Through Process. This is where individual owners account for profits on their personal income tax returns.
Money becomes personal (i.e. private and no longer a part of the company) by “Drawing” money from the LLC. Using the Pass-Through Process, Owners pay taxes on the Draw they receive from the company.
You can also choose to upgrade your LLC and get it taxed as a Corporation.
Corporate taxation works by electing to have your LLC file taxes as an S- or C-Corporation.
➤ MORE: Find out how S- and C-Corps compare.
This really becomes beneficial once your LLC is more established and makes good money consistently.
You may not ever want to change your tax status but it doesn’t hurt to have the option of Corporate taxation in your back pocket.
The main reason why anybody chooses to operate their business as an LLC is the personal limited liability protection. This ensures your personal assets —things like your real estate, vehicles, investments, personal accounts, etc.— are protected.
What do you need protection for?
If banks, creditors, or lawyers come collecting anything the business owes, your personal property is kept separate.
They are only allowed to take from assets belonging to the company and can’t touch what’s yours.
This limited liability protection is only effective when you clearly distinguish between business and personal finances. By doing this, the company stands alone as its own entity, with its own profits/losses, property, and debts.
The LLC is a completely separate entity from its Members(s).
Should the company file for bankruptcy, the protection extends and separates the Owners. It even comes to include a layer of separation between employees working “in” the LLC and Members working “on” the LLC.
Your credibility is much greater with an LLC. An LLC makes it easier to build rapport with your clientele.
LLCs hold more influence in the consumer marketplace because they carry a legitimate and professional image.
The positioning and branding opportunities that come with this authority explain why many entrepreneurs prefer LLCs.
How are LLCs Set-Up and Registered
LLCs are officially registered and recognized business entities by the state.
If you’re going to be running an LLC, you first have to form an LLC. This means you have to go through the registration process with your state.
Here are a few of the key steps:
Name Your LLC
When coming up with a name it’s important that it is unique. You can check the availability of the name you have in mind by doing a quick name search online.
File for an EIN
EIN stands for Employer Identification Number. This is an ID number for your business.
An EIN is necessary for you to pay taxes, open a business bank account, and complete the rest of the registration process.
Write up an Articles of Organization
The Articles of Organization is a document that includes the general information about your LLC.
Write up an Operating Agreement
The Operating Agreement covers the more specific details of your business.
Some states require you to submit this additional document although, for most states, filing an Operating Agreement is totally optional.
That being said, we highly recommended that you write one up anyway for clarity’s sake. It will help you keep everything official and on record.
The Operation Agreement involves things like how your LLC will be managed, how ownership is set up, how much say members have in the decision-making process, the percentage of ownership each member has.
Pay Filing Fees
If you plan on operating your business as an LLC you have to pay filing fees when you submit the required paperwork to your state. This charge depends on the state. It can be anywhere from 40USD to 500USD. For most states though, it’s less than 100USD.
On top of that, there are annual fees you should pay if you want your LLC to continue operating and your protection to remain active. This is normally cheaper than the initial filing fee.
Don’t get discouraged. There is good news.
Once all this is done, your LLC will be registered and operational.
You will receive the protections, the ability to take on business loans, and all of the other amazing benefits LLCs provide.
What is a Sole Proprietorship?
Believe it or not, you could already be running a Sole Proprietorship without even knowing it!
If you’re selling a product or service without ever having officially registered as a business…
You’re running a Sole Proprietorship.
Sole Proprietorships are the simplest and most straightforward businesses.
They’re a great route if you are thinking about testing out a low-risk business idea or want to monetize a hobby or one of your passions.
For example, you could be working a freelance position doing some sort of writing, mowing lawns in your neighborhood, or even flipping products online.
As long as you use your legal name as the name of your Sole Proprietorship, you can operate it without it being anything official.
The Simplest Business
The Sole Proprietorship is praised for its simplicity. The amount of paperwork and requirements needed to begin operations are also great (because there are none).
There is no barrier to entry to starting a Sole Proprietorship. All you have to do is sell something.
Sole Proprietorships aren’t officially recognized or registered to the state since they aren’t stand-alone entities.
The business only exists because the owner is running it. This does however put a lot of responsibility on the Owner.
As long as you’re making money under your legal name you are the proud owner of a Sole Proprietorship.
The Sole Proprietorship is the simplest type of business because there can only be one owner.
They are so simple that most of the Sole Proprietorships in America don’t even have employees. You can still hire employees if you want, you just have to complete some special paperwork for it to be legit and official.
All profits made by the business are automatically considered personal. This makes tracking finances worlds easier than other types of businesses.
Going with a Sole Proprietorship is a great way to do things, as long as there is little to no risk involved in your business.
Since Sole Proprietorships don’t distinguish between business and personal finances, you won’t receive any personal protections.
With a Sole Proprietorship, you are personally responsible for all aspects of the business.
One major benefit of this is the amount of control you have since you’re legally viewed as the business itself.
On the downside, you will be personally held accountable for anything that goes wrong.
Should your business get sued or owe money for whatever reason, it means you are the one getting sued. You are personally responsible for anything your business owes or does wrong.
These lawyers and creditors have free reign to possess your personal belongings to pay what is necessary. Your personal property includes any real estate, cars, assets, personal accounts, or anything else that you really don’t want to be put in the position of losing.
There is no separating your business’s finances from your personal finances. They are in the same pile. Your pile.
Now, this is nothing to worry about. It’s just the worst-case scenario.
The chance of something like this happening is unlikely, so long as the business you’re operating is of a low-risk nature.
Operating a Sole Proprietorship
In a Sole Proprietorship, you are the “sole” owner and operator, hence the name.
You are the business. If you stop doing what you’re doing, the business ceases to exist. There is no overarching, stand-alone entity, it’s just you.
If you want someone else to join in on your business venture, and it’s not your spouse, the business will no longer be a Sole Proprietorship. It would become a General Partnership.
Sole Proprietorships are run by one “sole” owner. Partnerships are run by a pair of “partners”.
Pretty simple, yeah?
Paying taxes in a Sole Proprietorship is also very straightforward.
You pay taxes on your business’s profits the same way you pay your regular income taxes. This is because all profits coming from your Sole Proprietorship are considered personal income.
Since the profits are automatically made personal. You call your business profits ‘personal income’ when filing your normal personal income tax returns.
The type of business you finally choose will have an impact on the initial success of your business. If it isn’t started properly it makes growing it harder. Most of your energy would be going into maintaining operation with less emphasis on the development and growth side of things.
By making sure your foundations are properly set you can build a business and see your vision come to fruition.
Nobody in their right mind would build a 20 story building, let alone a skyscraper, on the same foundation made for a regular 3 bedroom house. There’s also nothing wrong with building a 3 bedroom house.
By knowing the different types of business that are available, you can make an informed decision on which is best suited for your goals and the direction you want your business to go in.
Fortunately, there are hundreds of companies across the US and online that focus specifically on helping entrepreneurs get new businesses set up and registered with their state.
There are so many tax advisors, business professionals, and lawyers who are familliar with the details of each entity and how they work depending on the state.
Make sure to speak with legitimate experts such as these (not just your friends and family) before making any binding decisions. They have seen what works and what doesn’t. They know what will work best based on your unique needs.
We wish you much success in your journey. Good Luck!
Are you interested in getting the most out of your business?
“Business Initiative” is for general educational purposes only. “Business Initiative” does not offer any legal or financial advice. Anyone considering starting a business should speak with a lawyer, business professional, financial advisor, and tax expert before making any binding decisions when it comes to starting, operating, and growing your business. External resources should be used independently of “Business Initiative”. It is the responsibility of every reader to seek legal and financial advice from legal and financial professionals.