It’s one of the first questions you must answer when starting a business. Should I operate as a sole proprietor or an LLC? What’s the difference? There are advantages and disadvantages to both structures, but you can’t afford to put off the decision. Starting a business without an entity is one of the top 10 mistakes small business entrepreneurs make. So, which one is right for you? Many states have resources to help you figure it out, but if yours doesn’t, or you’re still unsure, here’s a primer.
A sole proprietorship is a business owned and operated by one person in which there is no legal distinction between the business and the owner. This reflects the reality of most new businesses – you are your business – and is the simplest way to get started. Your profits and losses are filed with your individual tax return. You might be okay having no separation between your work and private life, but if your business has potential liability issues – for example, if you sell food or work in healthcare – know that as a sole proprietor, your personal assets (like your house, your car, and your bank accounts) are fair game in a lawsuit.
LLC stands for limited liability company. It is a formal business structure that gives your business limited liability protection and flexibility on taxes. Combining elements of corporate and partnership models, an LLC takes more work to establish than a sole proprietorship does. Taxes and other paperwork are more complicated, as well. The primary benefit of an LLC, as the name indicates, lies in creating a legal barrier between the owner and the business. This is true even if the owner and the company are just the same person. On the other hand, know that even though an LLC can limit your personal liability it does not eliminate it entirely.
If you have, or plan to add, equity partners or investors, an LLC might seem the obvious choice. But it’s not your only option. You could form a partnership, but that, like a sole proprietorship, puts your personal assets at risk. Or you could form a corporation, most likely an S-corp, which offers liability protection and tax advantages, but also entails a host of corporate obligations that may seem onerous for a startup.
The right choice
When it comes to startups, both sole proprietorships and LLCs have their devotees. The right choice, however, is individual: what makes sense for you and your startup. Many businesses will be fine under either structure. The best choice depends on the nature of your business, your plans for growth, and sometimes on state laws that affect your industry. If the choice is not clear, a small business lawyer can advise you on the right structure for your business and draft any necessary paperwork for your state.