Choosing the setup for your business is one of the most important decisions you’ll ever make.
As someone looking to start a business, you’re probably considering whether to register as a limited liability company (LLC) or a sole proprietorship.
We’ll examine both business structures and help you decide which one is best for you.
Summary: Sole proprietorship vs LLC
To help you make the best decision for your business, we’ve created a LLC or sole proprietorship summary to cover the key differences between the two business structures.
| Key commercial feature | LLC | Sole proprietorship |
|---|---|---|
| Liability protection | Provides limited liability protection by allowing you to separate your personal assets from your business debts. | Offers little or no liability protection as your personal assets are at risk if your business incurs debts. |
| Taxes and taxation | Offers pass-through taxation, but you can also elect for corporate taxation. | Offers pass-through taxation with your profits taxed as personal income. |
| Registration or formation | You need to go through a formal registration process with the state, which includes filing articles of organization. | This set up is easier to set up and establish with minimal paperwork and fees. |
| Structure | LLCs offer flexible management structures which can be governed by members or managers. | Sole proprietorships are owner-managed, and you have full control over business decisions. |
| Costs or fees | Comes with steeper formation and maintenance costs, including state fees and potential annual reports. | Comes with lower costs with minimal fees and fewer administrative requirements. |
| Brand perception | LLCs are often seen as more credible in many industries. | Sole proprietorships can be perceived as less formal, less structured, and less credible in some industries. |
| Flexibility of ownership | Allows multiple members and offers flexible profit-sharing options. | Owned and run by a single trader or individual. |
| Regulatory requirements | LLCs are subject to more compliance rules and business regulations. | There are far fewer regulatory rules to follow as a sole proprietor. |
| Distribution requirements | You can distribute your profits among members based on what you’ve agreed. | All business profits go straight to the owner. |
| Who does it suit? | Businesses looking for liability protection and more potential to grow. | Small, low-risk businesses or sole entrepreneurs including freelancers and creative professionals. |
Key points about sole proprietorships
Do you have a small business idea and wondering if a solo proprietorship is the right structure for it? Read on.
A sole proprietorship is a business owned and run by a single person. The individual running the business pays personal income tax based on all profits and losses.
Sole proprietorships provide no liability protection as there is no separation between the owner’s personal and professional assets. While this type of business structure doesn’t come with liability protection, it's straightforward and easy to set up.
Here’s a summary of the key features of a sole proprietorship:
- You are solely responsible for your business’s income and losses
- You are entitled to all of your business’s profits post-tax
- You run the business alone
The advantages of sole proprietorships
Now you understand the key features of a sole proprietorship, let’s look at the key advantages of this popular business structure:
- You benefit from a simple organizational structure
- The registration process is cost-effective
- You get full control of how you run things
- You take all of the profits (as mentioned)
- The taxation process is simpler than an LLC
The disadvantages of sole proprietorships
To help you make an informed decision, let’s explore the potential cons of sole proprietorships:
- You are completely responsible for your business’s debts and liabilities. There’s limited personal protection
- It’s harder to attract potential investors as a sole proprietor as this setup can offer less growth potential than an LLC
- Scaling the business can be harder due to limited invest and access to less capital
- You must take charge of every business decision, process, and manage the entire workload
Key points about LLCs
A limited liability company (LLC) is a business formed at state level. Unlike sole proprietorships, LLCs are usually run by more than one person or ‘member.’
LLCS are viewed as a separate legal entity which means that the owners (or members) have personal liability protection. This means that any debts incurred by the business are separate from the owners’ personal finances or assets.
Here’s a summary of the key features of an LLC:
- LLCs often have multiple owners or members
- LLCs provide liability protection against your personal assets
- LLCs are usually taxed as an S or C Corporation
Related: How to start an LLC
The advantages of LLCs
You know the key features and functions or an LLC—now we’re going to look at the main benefits of setting one up:
- You will be shielded from the loss of personal finances or assets in the event of unpaid debit or a lawsuit
- You have more freedom and flexibility on how you run the business and can have multiple owners or members
- You may attract more potential partners or investors as LLCs are seen as having greater growth potential than sole proprietorships
- You can potentially reap tax benefits by setting up your LLC as a pass-through or flow-through entity
The disadvantages of LLCs
While LLCs offer their fair share of business-boosting benefits, there are some potential pitfalls you should know about. Let’s take a look:
- You usually have to register an LLC in the state where you do business. The registration process can also be complex and long-winded
- As some states charge additional filing fees during the registration process, setting up an LLC can prove costly
- There are additional administrative requirements (for instance, annual or bi-annual statement of information reports) that come with LLCs which can be challenging and time-consuming
- The state can involuntarily dissolve an LLC due to disputes like unpaid taxes or a failure to meet certain commercial requirements
The similarities between LLCs and sole proprietorship
When you’re deciding on whether to form an LLC or be a sole proprietor, knowing the similarities between the two structures is a good place to start. Let’s explore.
Administration and recordkeeping
First of all, as an LLC owner or a sole proprietor, you need to keep records of your expenditures for tax purposes. In both cases, these business expenses are deductible against your gross income. That said, logging your income and expenditure accurately is absolutely essential.
Tax requirements
If you’re a sole proprietor or a single-member LLC owner, you need to report your income or expenditure on Schedule C of Form 1040. Your net income is taxable to yourself whether you withdraw cash directly from the business or not.
Permits and licenses
While LLCs are a little more hands-on administratively speaking, both types of business structure require the owner (or owners) to meet relevant licensing or permit regulations. For example, a person who wants to sell online is automatically considered a sole proprietor if no other legal structure is selected. An LLC, on the other hand, must be applied for.
Whether you go the LLC or sole proprietor route, we recommend checking which permit or licensing obligations apply to you in your town, city, county, or state.
The differences between LLCs and sole proprietorship
Understanding the key differences between LLCs and sole proprietorship will also help you make a well-rounded decision about your business. Here are the main ones.
Liability and legal protection
LLCs are more expensive to set up and establish, but the liability and legal protection they offer could save you in the long run. On the flip side, while sole proprietorships are easier and more cost-effective to set up—you’re liable to foot the bill for any potentially costly legal disputes.
Regulatory responsibilities
Due to their more streamlined nature, sole proprietorships come with minimal regulatory responsibilities. LLCs on the other hand, require their owners or members to adhere to a variety of regulations, fees, and administrative obligations.
Dissolution processes
As a sole proprietor, you can dissolve the business with ease by canceling any relevant licenses or permits. Dissolving an LLC is a far more labor intensive process that comes with more steps and administrative requirements.
Who should use a sole proprietorship?
When you’re deciding whether to take on a limited liability company vs sole proprietorship, you should consider your business type as well as its aims.
To help you make an informed decision, here are some questions you need to ask yourself to see whether a sole proprietorship is right for you:
- Is my business a side hustle or seasonal in nature? If you’re running your business alongside your main source of income (side hustling) or it operates on a seasonal basis, a sole proprietorship will keep things simple.
- How risky is my business? If your business is relatively low risk in terms of potential legal disputes and operational overheads, sole proprietorship may suit as you’ll require less liability protection. Consultants and freelance creatives fall into this bracket.
- How established is my business? If your business is in its very early stages and you’d like to put an idea to the test, setting up a sole proprietorship could be a good idea. Why? Well, because it’s a swift, simple, and cost effective way to get things rolling.
- Am I self-funding my business? If you’re planning to self-fund your business without investors and have a simple business model, a sole proprietorship will save you paying out for potentially costly set up fees.
Who is an LLC for?
Still debating the question of sole proprietor vs LLC? Here are the questions you should ask yourself before deciding whether setting up an LLC is the right move for you.
- Am I searching for investors? If you’re looking to attract investors that can help you scale your business, an LLC will give you a greater chance of doing so. Typically, investors prefer LLCs over sole proprietorships.
- Does my business come with reasonable risk? If you operate in manufacturing or retail and handle valuable assets, an LLC will provide the liability protection you need to navigate any potential issues.
- Do I want to operate in multiple states? You can run a sole proprietorship in multiple states, but setting up an LLC will give you more structure, consistency, and protection when dealing with multiple regulations.
- Do I have a business partner or do I want one in the future? If you want to run your business with a partner or you want the option to do so in the future, setting up an LLC makes sense. With an LLC, you can create a clear structure and set operational boundaries to ensure everything runs smoothly.
As you can see, both LLCs and sole proprietorships offer their fair share of potential pros and cons. Ultimately, you should make a choice that aligns with your business style, model, and your long-term plans.
Work your way back through this guide, weigh the potential pitfalls and benefits of both structures, and you’ll come to a decision that benefits your business.
FAQs
Is it better to start as a sole proprietor or LLC?
When it comes to LLC vs sole proprietorship, you should take the time to understand the key features of each business structure. Consider your business model and goals to see which structure will best suit your needs. If you have a business partner or you operate in a high-risk industry, an LLC is probably your best option. If you’re a consultant or freelance creative, a sole proprietorship will likely suit your needs.
Can you convert a sole proprietorship to an LLC (or vice versa)?
Yes, you can convert your sole proprietorship into an LLC by filling out relevant forms including articles of organization within your state. You can convert an LLC into a sole proprietorship if you wish. But you’ll have to dissolve your existing business and set it back up as a sole proprietorship.
Which business structure is better for taxes?
While sole proprietorship provides simplicity when it comes to admin and recordkeeping, an LLC offers potential access to tax flexibilities and advantages. These advantages largely depend on your specific commercial situation. Concerning tax affairs, LLCs offer protections to personal assets and finances that sole proprietorships can’t.
