As a budding entrepreneur, you may face the issue of whether to start out as a sole proprietorship or a limited liability company (LLC). There are key advantages and disadvantages to each form of business and the nature of your enterprise and other business and personal circumstances may impact your choice. Here are some important factors to consider when assessing the main pros and cons of a sole proprietorship versus an LLC.
- Ease and Costs of Formation. In the United States, a sole proprietorship is the most popular business entity because it is the easiest to form. Compared to an LLC, a sole proprietorship is less complex and less expensive and demands less paperwork to start. You only need to begin transacting business and make sure you have any required licenses and permits and you have started your new enterprise. To establish an LLC, you must form and register your LLC entity with the applicable state agency, often the secretary of state’s office. You must draft and file articles of organization and pay a filing fee which can be hundreds of dollars in some states. Your LLC filing typically spells out your LLC’s name, principal office’s location, your owners’ or members’ names, the expected term of your LLC, and any other state-mandated information. Setting up an LLC requires more upfront time, money, and effort than a sole proprietorship so you’ll have to factor that in when deciding which entity is best for you.
- Raising Capital for Your Start-Up. Every business needs capital in order to start and maintain its operations. With a sole proprietorship, you will need to fund your own business using your personal resources or by seeking out loans. Establishing a line of credit or receiving loan approval from a bank or other lending institution may be a daunting challenge for a new entrepreneur. Often, you will be required to provide a personal guaranty for any loan to your business. The same holds true for single-member LLCs.
- Taxation of Your Business. For federal tax purposes, a sole proprietor’s net business income is taxed on his or her individual income tax return at the proprietor’s individual tax rates. A single-member LLC is a “disregarded entity” for tax purposes—that is, it is taxed the same as a sole proprietorship. But sole proprietorships and single-member LLCs may claim the full array of tax deductions for businesses. They both may also qualify for the new pass-through deduction of up to 20% of business income established by the Tax Cuts and Jobs Act for 2018 through 2025. Since federal income tax treatment is similar, this factor may not play a major role in choosing between a sole proprietorship and LLC. Consult a tax professional to determine if state or local taxes will impact your start-up’s tax situation.
- Your Role in Daily Business Management. If you like being your own boss, then a sole proprietorship or a single member LLC may be right up your alley. Under either of these approaches, you go solo in managing, marketing, financing, and determining the policies and direction of your business. You won’t have to consult with or receive prior approval from other owners on your business decisions.
- Risks of Personal Liability. Under the sole proprietorship, you and your business are viewed as one and the same. Therefore, you have unlimited personal liability for all of the debts and legal liabilities of your sole proprietorship. Your personal assets, such as your home or personal bank account, could be at risk to satisfy unpaid debts, legal judgments, and other legal obligations of your start-up. On the other hand, an LLC is a separate legal entity and an LLC member is normally not personally liable for the LLC’s debts or legal liabilities. As an LLC owner, you are mainly putting your financial contribution to your LLC, not your other personal assets, on the line. However, as an LLC owner, you may still be personally liable for your own conduct or LLC loans in some cases. For example, you may still be responsible if you personally guaranteed repayment of an LLC loan or if your own acts cause harm to a third party or to your LLC. Like any business person, it is important to consider appropriate liability and other forms of insurance to help protect your personal assets and your business. Overall, the sole proprietorship tends to expose a business owner to greater risks of personal liability. Assessing your comfort level with personal liability risks should be an important aspect of your decision-making process.
The Small Business Administration provides general information about starting and managing your new business at www.sba.gov/category/navigation-structure/starting-managing-business. You can also check out information about small business loan and grant programs at www.sba.gov/category/navigation-structure/loans-grants.