When starting a business, one of the critical decisions you’ll have to make is choosing the ideal structure for your entity. Each business structure comes with its features, advantages, and disadvantages.
Your aim should be to select the best fit for your entity that allows you to meet your business goals. Before you do that, take some time to learn each structure’s characteristics and how it differs from others.
How to Choose Between an LLC and a Sole Proprietorship
This post will cover the differences between an LLC and a sole proprietorship. Find out which option is better for your organization.
What Is a Sole Proprietorship?
A sole proprietorship is a business structure run and managed by one person. This structure type is the most basic, and it doesn’t take much expertise or capital to form and operate.
A sole proprietorship is a perfect choice for someone who’d like to test a business idea without going through the process of registering an entity. It’s the easiest way to start a business since you don’t have to file it with the state. Click here for the pros and cons of a sole proprietorship
What Is an LLC?
A limited liability company, abbreviated as an LLC, is an entity structure formed to protect its owners from personal liability. Anyone can register this business structure in the United States, whether a citizen or a foreigner. The owners of an LLC are called members.
Unlike a sole proprietorship, you have to register an LLC with the state. There are also protocols and requirements you need to meet for you to be able to form an LLC.
There are different types and classes of an LLC. They include:
- Single-member versus multi-member LLCs
Single-member LLCs have only one owner, while multi-member LLCs have more than one owner.
- Holding LLCs versus operating LLCs
Holding LLCs exist solely to hold assets such as real estate. They don’t manufacture or conduct any operations. Operating LLCs, by contrast, exist to conduct business activities such as processing, marketing, and selling goods and services.
- Member-managed LLCs versus manager-managed LLCs
In a member-managed LLC, the members are both owners and managers of the company. They own and run the daily operations of the entity. In a manager-managed LLC, the members own the LLC but employ managers to manage day-to-day operations.
- Foreign LLCs versus domestic LLCs
A foreign LLC is an LLC registered in one state but operated in another. A domestic LLC, by contrast, is one registered and managed in the same state.
- Series LLC
A series LLC is one where there is a parent LLC and individual LLCs underneath it.
- Professional LLCs (PLLCs)
A professional LLC offers professional services such as medical or legal assistance. This LLC requires a license to operate.
Side By Side Comparison: LLC vs. Sole Proprietorship
|Offers personal liability protection||No personal liability protection|
|Registration with the state required||No requirement to register with the state|
|Is a separate legal entity from its members||Is not a separate legal entity from its owner|
|Costly to form||Easy to form and dissolve|
|Profits and losses shared equally among members||The owner keeps all the business’ profits and incurs losses alone|
|Can undergo pass-through taxation or double taxation||Undergoes pass-through taxation|
|Owners make decisions together||The sole proprietor has the final say on what happens to the business|
Detailed Difference Between LLCs and Sole Proprietorships
You’ve already seen a side-by-side comparison of LLCs and sole proprietorships. Let’s now discuss in detail the differences between these two business structures.
Personal Liability Protection
One notable characteristic of sole proprietorships is they offer no personal liability protection. The owner/sole proprietor is personally liable for paying the business’ debts and liabilities. If the entity can’t pay its debts, the lender can claim the owner’s assets.
An LLC offers personal liability protection to its members. The members of an LLC are not personally responsible for the company’s debts and liabilities. Lenders cannot claim the owner’s assets if the LLC defaults on a loan.
Separate Legal Entity
Sole proprietorships are not separate legal entities from their owner. This means that they cannot buy, sell or own assets in their name. Sole proprietorships cannot get into a lawsuit or enter a binding contract or agreement in their name.
LLCs and their members are separate legal entities. They can buy and own assets. They can also get into lawsuits, hire an attorney, or enter into a contract in their own right.
Most states in the US don’t require you to register a sole proprietorship. The only thing you may have to do is file for a DBA registration if you use a fictitious name other than your personal name.
As for an LLC, you need to register this business structure with your state. The LLC registration process also requires you to meet specific protocols and requirements. For example, you need to file articles of organization and create an operating agreement. This agreement identifies the members of an LLC and highlights how the LLC will operate.
Ease of Formation and Dissolution
Sole proprietorships are the most straightforward business structures to form and dissolve. You don’t need to register them with the state, nor do you need to structure your management. You, the sole proprietor, are the only one who decides whether to dissolve the business or not.
LLCs are more costly to form than sole proprietorships. They also require you to meet specific requirements to register with the state. To dissolve an LLC, every member needs to consent to this decision.
One benefit of a sole proprietorship is there is no double taxation. Since you and your business are not a separate legal entity, the IRS taxes you as one entity at the personal income level.
As for LLCs, the IRS allows them to choose the taxation method they want. LLCs, pay taxes at the corporate level like a corporation or the personal level like a sole proprietorship.
Profit and Loss Sharing
In a sole proprietorship, you enjoy all the business profits alone. Being the only owner, you are not required to distribute them amongst your employee or shareholders. The downside, however, is you suffer losses alone.
The only time you enjoy profits alone in an LLC is if you run a single-member LLC. In other LLC types, profits get divided equally among all members or according to the operating agreement. The good side, however, is you won’t suffer losses alone.
Operations and Management
The decision-making and implementation processes are quicker in a sole proprietorship than in an LLC. You, the sole proprietor, are the only decision-maker. You don’t have to consult or seek approval from anyone.
An LLC, by contrast, requires you to have a structure. You may have to appoint managers to make decisions and run daily operations. LLCs also, in most cases, have employees and a more complex operations structure, thus requiring an EIN.
Compliance and Paperwork
There are conditions to meet to register an LLC and keep it in good status with your state. First off, you need to create an operating agreement and hold member meetings. You also need to obtain an EIN if you plan to hire employees and file annual returns with your state. Registering a sole proprietorship doesn’t require you to meet any compliance conditions, nor do you have to submit any paperwork.
How to Choose the Right Structure
When should you select a sole proprietorship over an LLC or vice versa? Check out the factors to consider when choosing a suitable structure for your organization.
Ease of Expansion
If you want to expand your business or seek funding opportunities, it’s better to go for an LLC. Sole proprietorships have limited expansion opportunities. In most cases, the sole proprietor is the only investor in the business. And thus, the entity is limited to how much the owner is willing and able to invest. It’s also easier for an LLC to obtain external funding than a sole proprietorship.
If you are looking to test a business idea or concept, you may want to select a structure that doesn’t take much time or capital to start. A sole proprietorship would be a better option, as most states won’t require you to register this business structure. You also don’t have to meet any compliance requirements or submit any paperwork.
Personal Liability Protection
One benefit that comes with an LLC is personal liability protection. This business structure is ideal for a business owner or entrepreneur with many assets.
Sole proprietorships don’t offer any liability protection. You risk losing your personal assets if you take a loan for your sole proprietorship and default on it.
Number of Owners
Sole proprietorships have only one owner. If there is more than one owner in your entity, you may want to register an LLC.
Citizen or Foreigner
As a foreigner in the United States, you can only register an LLC or a C-corporation. You can’t start a sole proprietorship.
When selecting a business structure, your goal should be to choose the one best suited for your organization type. If your decision is between an LLC and a sole proprietorship, you may want to consider various factors.
The first one is personal liability protection, which LLCs offer and sole proprietorships don’t. Another factor to consider is if you plan to expand your organization or seek external funding. It’s easier to expand and get outside funding for an LLC than for a sole proprietorship. Lastly, if your entity has more than one owner, you can only select an LLC. Sole proprietorships have only one member.
Below are a few resources for more on the differences between structuring your business as an LLC or sole proprietorship. The links lead to the latest and most popular search results, so you always have updated information at your disposal.
Books are an excellent way to dive into structuring your business. There are many books on the topic. However, because I’m a visual learner, I’m not too fond of reading, so with nonfiction books, I rarely read the book from cover to cover. Instead, I jump to the chapter that has the information I need. Otherwise, I would never build a library of books.
I use Google News a lot when researching a topic because I feel the news gives you a different perspective. Also, if the media covers a topic, it has some merit and is worth looking into. So why not take a few minutes to see what’s in the news related to choosing between a sole proprietorship or an LLC.
If you’re a visual learner, you probably spend a lot of time on YouTube. In addition to entertainment YouTube has a lot of tutorials and informational videos. So why not take a few minutes to see what videos are available related to the difference between structuring your business as an LLC or a Sole proprietorship. One tip to keep in mind is when watching a video take notice of the related videos. They will appear on the left or at the bottom of your screen depending on the device you’re using. I find a lot of these videos offer related topics I hadn’t considered.