Starting your own business can be an exciting experience; you get to be your own boss! But then comes the decision to decide whether your business will be a sole proprietorship or a limited liability company (LLC). Which one should you pick, and why?
What are the main differences between sole proprietorships and LLCs?
Simply put, a sole proprietorship is an unincorporated business owned by the individual that operates it. Meanwhile, an LLC is a business entity created under state law that is legally separate from the owner. While an LLC can have a single owner just like sole proprietorships, there are notable differences between the two:
- The maximum number of owners – Sole proprietorships can only have one owner – it’s in the name, after all. Conversely, LLCs may have unlimited owners, whether it’s another person, a corporation, or even another LLC.
- Business control – Because there’s only one person in charge of a sole proprietorship, that owner can make whatever business decisions they want without needing advice or input. Naturally, they’ll still need to recruit employees, legal advisors, and accounting personnel for daily business management, but sole proprietors make the decisions to keep the organization afloat. In the case of LLCs, each member (shareholder) decides on all company matters based on their ownership stake. This means an owner with a 25% stake would have a one-quarter vote in significant business decisions, for instance.
- Taxation – While single-member LLCs can be taxed just like a sole proprietorship, and both can operate as pass-through entities (the owners can pay taxes so that the business itself doesn’t have to), LLCs have the advantage of selecting other tax options. They can stick with pass-through taxation or become an S-corporation or C-corporation. In an S-corporation, each shareholder will report and pay their share of the business’ income. Meanwhile, a C-corporation means the LLC itself will pay a corporate income tax at the federal level.
- Accountability – The most significant difference is how the two business types approach liability. Without the legal separation between their finances and business, sole proprietors can be held liable for any debts and obligations they incur while they operate the business. The owner must also file for personal insolvency if the company goes bankrupt. This also means that if someone wants to sue a sole proprietor, they can name the owner and even come after the owner’s other assets. But in an LLC, the business is a legally separate entity from the owner. Owners can file for the business’ bankruptcy and won’t be on the hook for any debts.
While LLCs afford some level of protection from lawsuits, shareholders are not entirely free from lawsuits accusing them of negligence or fraud. It is essential to learn these distinctions before starting a business so that you can save yourself from potential legal trouble down the road.