In today’s world, you need financial independence if you want to secure your freedom, provide for your family and community, and live your life to the fullest.
If you’re serious, starting your own business is the most rewarding way to do this.
When you’re the boss…
- You can’t be fired.
- You control how much you get paid.
- You can replicate your system once you build it.
Many entrepreneurs start with a Sole Proprietorship or Limited Liability Company (LLC) because they are the easiest bases to start with and build on.
Sole Proprietorships and LLCs share a few basic characteristics but they differ largely in how you can optimize them and the protections you receive.
In this article, you’ll find a clear breakdown of the pros and cons of the most popular business entities in America right now.
When you see what’s available and understand the implications of each setup, you’ll know which type of business best fits your budget and your goals.
Advantages of LLCs
A Limited Liability Company gives you personal protection, credibility, and tax options.
Limited Personal Liability Protection
LLCs offer Limited Personal Liability Protections by distinguishing between business finances and personal finances.
This liability protection is the reason why millions of entrepreneurs prefer LLCs over Sole Proprietorships.
When you conduct business as an LLC your personal belongings are protected from business lawsuits and debts.
Your assets include things like your house, car, personal bank accounts, and any other investments you may have.
Let’s say, your LLC catches a lawsuit or owes money to creditors:
In both situations, the claim is only made against the LLC itself, not you and the other Members.
When you have an LLC, your personal property remains protected from the courts and creditors.
This means the LLC pays from its assets, not from your pockets.
If your LLC owes more than it’s worth, creditors can take the entire business.
Different Tax Setups
An LLC gives you a few tax options to choose from. Whatever setup best fits your business’s needs, you can have it.
Plus, you can always change your tax status in the future.
As an LLC owner, you use the Pass-Through Process to pay taxes by default.
In the Pass-Through Process, the LLC’s taxes are “passed” on to you and any other owners.
Figuring out how much you owe is simple.
A member’s share of the company’s taxes is the same as their share of ownership in the company.
To pay income tax as a Single Member LLC, you will use a 1040-SC Form.
This is the same tax form Sole Proprietorships use.
Just submit this form alongside your regular personal income tax.
You can upgrade your LLC to an S- or C-Corporation.
The tax savings from upgrading are only worth the hassle if your business is bringing in significant profits regularly.
In other words, S-Corps and C-Corps are better suited for when you’ve gotten your LLC off the ground and established yourself in your industry.
LLCs are the most common business structure in America because of their scalability.
As you grow your business, you can change your LLC’s characteristics to fit your needs.
Your LLC’s protections remain active so long as you follow state and federal laws and regulations.
If you are making 20,000USD a year and own a Honda you get the same protections as someone making 20,000,000USD a year driving a Lambo.
To put it simply, your growth in an LLC isn’t limited as much as it is for a Sole Proprietorship.
Credibility and Rapport
The LLC is a legally recognized business entity.
Although LLCs might not get as much hype as Corporations, banks and investors are more likely to help you raise start-up capital and take out business loans when they see you put serious effort into creating and maintaining your LLC.
People also think of LLCs as official and reputable businesses.
Having an LLC is great for marketing and building your brand.
LLC management is very flexible and can be optimized to fit your business model.
There is no limit on how many owners an LLC can have.
As long as one member is a person, additional members can even be groups, organizations, or other businesses altogether.
Once you figure out your members, you decide if you want your LLC to be Member Managed or Manager Managed.
As a general rule of thumb:
- The owners of a Member Managed LLC are actively involved in daily operations
- The owners of a Manager Managed LLC are passively involved in daily operations
With so much variation in the LLC’s management, your distribution of ownership can be biased.
While most founders divvy up ownership based on each member’s initial investment, some leave room to account for each member’s continual contribution to the LLC.
Pros of Sole Proprietorships
Sole Proprietorships are the simplest business entity.
They are cheaper to start than LLCs because they don’t require registration.
You are the boss in a Sole Proprietorship.
You have total control over the success of your Sole Proprietorship.
You take home all the profits.
You don’t need other owners to agree with you on important business decisions because there are no other owners (unless you’re a co-sole proprietor with your spouse).
This is a huge advantage Sole Proprietorships have over LLCs where control and ownership are shared.
Sole Proprietorships are by far the easiest business to start.
There is no registration required to be a Sole Proprietor.
The only prerequisites are any relevant licenses or permits for your kind of business.
These are only required on a state-to-state basis so you might not need anything at all.
After things are up and running and the money is rolling in, the only kind of “checking in” you have to do is pay your taxes to the Feds, which is straightforward.
In Sole Proprietorships, all business profits are automatically considered personal profits.
With everything being personal, paying taxes is as simple as including your business profits/losses in your personal income tax returns.
This is the beauty of the Pass-Through Process.
Your business taxes are “passed” on to you.
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Cons of LLCs
If you want the protection of an LLC, you have to go through your state’s registration process and stay up-to-date with the maintenance requirements.
The exact registration requirements vary from state to state and can become quite the headache as you deal with government bureaucracy.
Thankfully, every state has companies specializing in completing your LLC’s registration for you.
You need to find a trusted Registered Agent for your LLC.
This person is your LLC’s point of contact with the government.
They send and receive important documents to/from the state.
Your Registered Agent can either be one of your LLC’s owners or you can hire someone from a third-party service.
Business Name Restrictions
Before settling on a name for your LLC you have to make sure it’s not already being used in your state (or county).
Check a name’s availability on your Secretary of State’s website before using a third-party service.
While you’re at it, make sure the name you have in mind is allowed by your state for your kind of business.
You could name your business “Larry’s Lawncare, LLC’’ or even just “Larry’s Lawncare”.
However, you can’t call it “Larry’s Lawncare, Incorporated’’ because it’s not a Corporation.
The Cost of Doing Business
The startup registration costs for LLCs range anywhere from 40USD to 500USD depending on the state, though most of the time filing fees are less than 100 bucks.
Then, every year after you register, there is a recurring annual filing fee.
The annual fee is generally cheaper than the registration fee, sometimes it’s free.
Some states charge more for the annual filing fee than they do for the registration fee.
Along with the annual payment, you must also submit special documentation to keep the filings up-to-date.
There are third-party services you can hire to compile and submit the correct information for you.
You can lose your LLC if you somehow forget to pay the recurring filing fees or don’t submit the necessary paperwork on time.
For your Limited Liability Protection to remain effective, you have to keep your records in order and submit quarterly and annual reports to federal and state agencies.
Upgraded LLCs, a.k.a. S- and C-Corps, have even more requirements you have to follow to maintain your specialty tax status.
By running a profitable business you are called self-employed, even if it’s only a side hustle.
In a regular 9-to-5 your employer automatically takes Social Security and Medicare taxes from your paycheck or salary before you even get paid.
Now that you’re the boss, you are personally responsible for paying these taxes.
Lucky for you, the government makes it easy to give them your money by grouping Social Security and Medicare and calling it “Self-Employment Tax”.
Disadvantages of Sole Proprietorships
Sole Proprietors lose out on liability protection, flexibility, and brand name credibility.
No Personal Liability Protection
You are personally held responsible for any claims made against you or your business since Sole Proprietorships don’t separate between business and personal finances.
As a Sole Proprietor, you run the risk of losing your personal belongings in the unfortunate event your business gets sued or is unable to repay any outstanding debts.
If the money you’ve set aside is insufficient, “they” will take your personal property (assets, cars, investments, personal accounts, etc.) to cover what you owe.
To prevent this, you can get certain types of liability insurance.
Keep in mind: These plans don’t cover everything LLC protections cover.
No Tax Breaks
Just like an LLC, Sole Proprietors pay Income Tax and Self-Employment Tax.
As we mentioned earlier, Self-Employment Tax is a technical name for the combination of Social security and Medicare tax.
These taxes are unavoidable and must be paid.
Let’s say your Sole Proprietorship is a side hustle supplementing another job:
You pay the same tax rate on your side-hustle as you do for your main source of income (i.e. your salary).
If you make a lot from your “main gig”, your Sole Proprietorship may suffer from most of its profits going toward paying the tax rate of your day job.
As you build your business, your responsibility and risk grow with it.
You become limited to what you can handle on your own and will have to think about upgrading to an LLC and hiring outside help.
Lack of Credibility
The barrier to entry for Sole Proprietorships is practically nothing.
Without any upfront requirements, there is nothing preventing someone with bad products or bad intentions from starting a Sole Proprietorship.
It’s very difficult to get professionals to trust and invest in your business when anyone can start a Sole Proprietorship whenever they want.
Using Your Legal Name
Your business’s name has to be your legal name. This can harm your Sole Proprietorship’s public perception.
If you want a custom, industry-specific name, you should apply for a DBA name.
DBA stands for “Doing Business As…”. It’s like an alter ego you use while conducting business.
Here’s the practical difference:
Phil Collins (no relation) is a home flooring contractor.
Without a DBA, people refer to Phil and his business as: “I think his name is Phil Collins, he lives down the street. Doesn’t he do flooring and stuff?”
On the other hand, Phil can use a DBA and name his business: “Aspen Flooring and Concrete”.
Which one sounds more professional?
DBAs give you credibility, and branding opportunities, and protect your identity.
Most states don’t require DBAs.
You may be perfectly fine using your legal name depending on your business.
If you want the extra edge of a DBA just submit the required paperwork to your State Secretary or County Clerk’s office and wait for the “go ahead”.
LLC or Sole Proprietorship: Which is Right for You?
When deciding on which business type is best for your level of experience, your goals, and your specialty there are many factors to consider.
If you want something more basic, without any protections or set-up requirements:
The Sole Proprietorship is your best bet.
If you want to protect your personal property and don’t mind the added complexity of registration:
The LLC is the business entity for you.
Although they differ in their protection, Sole Proprietorships and LLCs have one major aspect in common:
Both business entities pay taxes using the Pass-Through Process.
This is the default for LLCs but you can always upgrade and get taxed like a Corporation.
Build your business on the proper foundation, especially if you have big goals and see yourself wanting to expand in the future.
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