When starting a new business, the company legal structure you choose can make a big difference when it comes to taxes, finances and liability. In a previous post, we discussed the pros and cons of structuring as a C corp and an S corp. In this post, we’ll go over two other popular legal structures for small businesses: a sole proprietorship and a limited liability company (LLC).

Sole Proprietorship

Over 70 percent of US businesses are structured as sole proprietorships, according to the US Small Business Administration (SBA). With this setup, your business is unincorporated and run by only one individual. With no partners or corporate structure, there is no legal distinction between the business and the owner. That means if you are the sole proprietor, you get all the business profits — but are also accountable for all the business debts and liabilities.

Pros

  • A sole proprietorship is usually the most simple and inexpensive way to run a business. Start-up costs are lower and there are no legal filings — you basically just start working, says New York City startup attorney Lori Hoberman.
  • Taxes are also easier. There’s no separate business tax return, you simply include all the profits and losses on your individual tax return.
  • As a sole proprietor, you have complete control over all business decisions, and you get to pocket every penny you make.

Cons

  • You have absolutely no liability protection. This is the main downside for running your business as a sole proprietorship. If your business is found liable for any damages, all your personal assets — house, car, savings — are up for grabs.
  • Raising capital is more difficult. Most financial institutions require that small businesses incorporate before lending any money.

Limited Liability Company (LLC)

A limited liability company, or LLC, is a business structure that combines elements of a corporation with some of the tax efficiencies and operational flexibility of a partnership. While the exact setup of an LLC depends on the state in which you operate your business, they all have many common features.

Pros

  • The main benefit of setting up an LLC is that you get liability protection. If your business is found liable in a lawsuit, plaintiffs can only access company assets.
  • An LLC structure allows for multiple owners.
  • You retain pass-through taxation, just like with a sole proprietorship. This tax benefit extends to all LLC owners, meaning you and all your partners can claim profits and losses on your individual tax returns.

Cons

  • Legal filings and fees are necessary. The exact documents vary in each state, but you will need to file a certificate of formation.
  • If even one partner leaves an LLC, the business is immediately dissolved. The remaining partners must fulfill all remaining legal and business obligations to close the business, according to the SBA.

Choose a Sole Proprietorship over an LLC:

  • If there’s a low possibility of incurring significant business liabilities, says mergers and acquisitions attorney David K. Staub. For example, if you’re selling art, you’re probably safe. But if you’re selling food, there’s a much larger potential for inflicting injuries, and you could lose all your personal assets.
  • If you see no need for outside capital to grow your business.
  • If you won’t need to transfer intangible assets like contracts or permits to a buyer of your business in the case that you choose to sell it.

Choose an LLC over a Sole Proprietorship:

  • If you expect your company to need other partners or owners in order to grow and achieve your business goals.
  • If there’s a significant chance that your business could incur liabilities that would put your personal assets at risk.
  • If there’s the chance you might transfer intangible business assets to a buyer of your business.

Hopefully, this gives you a good idea of whether you want to run your small business as a sole proprietorship or an LLC. Contact an UpCounsel business formation attorney for more help to make sure you meet all your business goals and avoid potential headaches.

 

Sources

Photo: “The Basics of Business Structure” by Michael Spadaccini, used under Entrepreneur

About the author

Alex Liu

Alex Liu

Alex began his career as a scientific legal consultant and then as a journalist researching and reporting on health policy and health sciences. At UpCounsel, he enjoys researching and analyzing data to help businesses make informed decisions. In his free time, Alex is working on a documentary.

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