Finance Forward Blog

Congratulations! You have an idea and now you need to focus on launching your very own business.

For many, this is an opportunity they’ve been dreaming of. It offers freedom from the typical 9 to 5 desk job. Exciting as it may seem, the territory also comes with a lot of questions and challenges.

One of the earliest ones you’ll face is choosing the right legal structure for your business venture. Some entrepreneurs think that all businesses are the same. However, from a legal point of view, this couldn’t be more wrong.

It may come as a surprise to you that there are several kinds of business entities, each with a different liability clause, tax implication, and cost.

Which Business Structure Is the Best for You?

Deciding between an LLC and a sole proprietorship can be overwhelming. The structure of your company determines how your organization will be legally recognized.

Moreover, the choice you make will impact your revenue model, how much taxes you will pay, the amount of paperwork to do, and how much liability you will have.

But even before you can attempt to answer this question, you need to understand their differences. For now, let’s take a closer look at LLC and sole proprietorship. This will help you choose the right legal structure for your small business.

What Is an LLC (Limited Liability Company)?

LLC is a business structure where a company exists separate from its owners. That means owners aren't personally held liable for the company's debts or liabilities. The LLC must deal with them.

One person (Single-Member LLC) or more people (Multi-Member LLC) can own an LLC. Members can manage the LLC's day-to-day operation, or they may elect a manager to do this. Whatever the case, you should draft an operating agreement to document membership details and how the LLC will operate.

Advantages of Forming an LLC

1. Separates you from your business

The purpose of an LLC is to create a separate business entity from yourself. That means there is no mingling of personal and commercial assets, so you are not personally accountable for commercial activities.

2. Protects personal assets

An LLC helps to protect your personal finances and assets from business liabilities. If lawsuits or creditors cannot access them, you won’t lose anything due to a business dispute.

3. Has a higher level of market credibility

As an LLC, it’s easier to generate equity and debt financing. This is because the company is a separate business entity with its own credit score. So when you apply for a loan, it may get categorized as a business loan, not a personal one. In such a situation, you can get more credit and debt financing options.

4. Enjoy tax benefits

Tax benefits for an LLC show up in different ways. For instance, an LLC may have less IRS scrutiny than a sole proprietorship. Also, it’s often easier to deduct certain expenses through an LLC.

Disadvantages of Forming an LLC

1. Complete state-related paperwork

When registering your LLC with the state, you need to ensure no one owns another business with the same name. You can check this through the Secretary of State’s office. You will also need to file Articles of Organization and specific industry licenses. Keep in mind fees and rules vary from state to state.

2. Greater filing costs

The cost of completing and filing the annual tax return for an LLC is higher than that of a sole proprietorship. Additionally, you may have to pay state business taxes and unemployment taxes.

3. Possibly lower tax benefits

Tax benefits in an LLC may be lower until the business makes money on a larger scale.

Now that you have a better idea about LLCs let's look at your other option – a sole proprietorship.

What Does Sole Proprietorship Mean?

When you do not form a separate business entity and continue to operate the business by yourself, you become the sole proprietor. It is a common option for those new to the business climate.

After all, it’s the simplest business structure. There are no partners involved - you call all the shots and get to keep all the profits.

Advantages of a Sole Proprietorship

1. There is less paperwork

You don't have to deal with state paperwork unless your industry requires specific licensing paperwork. Moreover, annual state filings are rare.

2. Greater access to profits

You receive all the profits (but are liable for the losses). There is no one else involved.

3. Filing taxes is simpler

You need to pay only personal federal, state, local, and FICA taxes. You won’t have to pay specific business or unemployment taxes.

4. Acquire more tax benefits

Since you are self-employed, you can enjoy extra tax benefits. You can turn some of your personal expenses into business expenses. For example, it could mention the business use of your home or car.

But is it a wise decision? Let’s look at the drawbacks of sole proprietorship.

Disadvantages of a Sole Proprietorship

1. Sole proprietorship offers you no protection

Because you are the sole proprietor, you are responsible for all debts and liabilities. This can be a risky choice. For instance, if someone sues your business, you can lose all your assets. That includes your home, car, and money in the bank. This structure does not protect anything.

2. It’s hard to generate equity financing

Investors may not want to invest in a business that is risky. This could limit funds needed to sustain and expand the business.

3. Lower market credibility

If you do not operate under a trading name, it may not be easy to establish credibility. In fact, financial institutions may consider your loan as a personal loan, limiting your potential. You are, in some cases, using your Social Security number for payments / documents.

By now, LLCs and sole proprietorships hopefully make a lot more sense.

Which Is Better: LLC Or Sole Proprietorship?

As an entrepreneur, you need to closely examine what each business structure has to offer. The answer to this question depends on several factors of your business.

However, it is difficult to overlook the protection an LLC can offer, even if this option entails additional fees, paperwork, and taxes. In general, this is the better option.

On the other hand, sole proprietorship means you get to run the business on your own and reap all the rewards. But the most significant drawback is that you are entirely liable. Moreover, raising capital may become challenging for a sole proprietor.

Final Thoughts

Establishing a business takes hard work and dedication. Choosing the right structure is merely the first step towards long-term success. Knowing the right way to start your company will significantly impact other decisions you make down the road.

Remember, you are dealing with a crucial aspect of your business. Consider seeking the counsel of sound business experts, accountants, and lawyers. They will ensure that you’re following all the rules and regulations.

Moreover, they have the expertise to help you build a strong legal foundation for your business. This will save money and protect your investments from the get-go. If you have any questions, please feel free to reach out to the team at J. Hall & Company. They can lead you in the right direction, or get you in front of someone that can help.