If you're getting ready to go out on your own as a small business owner, you'll need to decide how to structure your company. If you're a solopreneur, that probably means you'll need to decide if you should set your business up as a sole proprietorship or a limited liability company (LLC). In order to make a wise decision, you'll first need to understand some basic facts about these two types of businesses.
What Is a Sole Proprietorship?
A sole proprietorship is an unincorporated business that is owned and operated by one individual. Enterprises with more than one owner cannot be sole proprietorships. With a sole proprietorship, no legal filings are required to form a business entity, because there is not one. There is also no requirement to file separate business taxes. Instead, the owner simply pays personal income taxes on all the profits of the business. This can save time and money, both important resources for small business owners. However, with this type of business structure, the owner has unlimited personal liability for business-related debts and obligations.
What Is an LLC?
A limited liability company is a legal business entity, so it does shield the owner's personal assets from liability for business debts. In order to form this type of business, you will be required to file the company's articles of organization with your state's Secretary of State. Additional documents and filing fees may be required in some states. Municipal requirements may also apply. LLCs can have multiple owners (referred to as members), but they can also be formed with just one member. This has not always been the case, but all states now allow solo owner LLCs. In some states, the term single-member LLC (SMLLC) is used. LLC taxation can work the same as with a sole proprietorship, unless the entity opts to be taxed like a corporation.
Sole Proprietorship vs. LLC: Key Factors to Consider
Now that you have an understanding of the basic similarities and differences between a sole proprietorship and an LLC, the next step in deciding which structure is right for your business is to think through the implications of each option in light of your specific situation.
If you are starting out on your own, but plan on taking on partners or other owners fairly soon, it may be best to set up an LLC. That way, there won't be a need to reorganize once you are no longer the sole owner. Going through such a reorganization can be costly and time-consuming. If you know you'll need to do this before long, it is ideal to get set up properly from the beginning. However, if you plan to remain a solopreneur forever (or indefinitely), either option could work. In that case, base your decision on other factors.
If you want to make sure that business creditors can't easily come after your personal assets, an LLC is a better choice than the unlimited liability of a sole proprietorship. This is particularly important if you have significant personal assets or your company is expense-heavy or high risk in any way. Please note that LLCs do not offer absolute protection of personal assets for the owner(s), especially (but not limited to) SMLLCs. Consult a licensed business attorney in your state before forming your business, as you may need to consider forming a corporation, or other strategies to protect your personal assets.
To operate as an LLC, you will have to meet all state requirements for officially establishing a business entity. There are fewer requirements for starting a sole proprietorship, but that doesn't mean you can necessarily just decide to begin a business and start working without having to meet any requirements. For most types of businesses, there are at least some federal, state, county, or city requirements that will apply, regardless of whether you opt for an LLC or a sole proprietorship. These include things like business registration, permitting, and/or business licensure. It's generally faster and less costly (upfront) to start a sole proprietorship than an LLC, but it's not effortless.
Seek Legal Guidance
Choosing a business structure is a big decision that can impact not just your entrepreneurial enterprises, but also the security of your personal assets. While it's natural to look for the fastest and lowest cost option to start a small business, these criteria aren't the only factors to consider when making a long-term decision that can have serious long-term financial implications. This is why it is so important to consult with an attorney in your state who specializes in small business formation before making a final decision. The money you invest seeking legal guidance is an important investment in the success of your business as well as your personal finances.