When deciding between a sole proprietorship vs. an LLC (limited liability company), consider the pros, cons, and risks associated with each business structure. LLCs generally offer more benefits than sole proprietorships, but they take a bit more effort to set up and maintain.
A sole proprietorship is as simple as it gets. It’s just you and your business, without any partners or shareholders. This is the default business structure for single-person businesses, so you won’t need any paperwork to make it official.
Easy to become. You don’t need to file anything to be a sole proprietor. If you’re selling products or services, you already are one. However, you’re still subject to IRS regulations, like paying self-employment taxes.
Easy to run. Sole proprietors don’t need to keep minutes, create articles of organization, separate business and personal finances, or do any of the things that owners of other business structures are required to do.
No separate business tax returns to complete and file. There’s no separation between your personal finances and your business finances in the eyes of the government. Your business’s finances "pass through" to your personal return, so you only have one tax return to fill out.
No liability protection. Because there’s no separation between your personal finances and your business finances, your personal assets are at risk. In other words, if an unhappy customer sues you, your savings or your house could be used to settle the suit.
Little room for growth. A sole proprietorship can only have one member. If you ever want to partner up with someone else, you’ll need to pick a new business structure.
A limited liability company is a unique business structure, combining the flexibility of sole proprietorships or partnerships with the legal protection of a corporation. It takes a bit of work to create one, but the process isn’t too difficult.
Liability protection. In an LLC, your personal finances are separate from those of the business. As long as you keep the two separate, and behave ethically, the "corporate veil" should provide legal protection.
Room for growth. An LLC can have one member, or many members, and you can add more members as time goes on.
Tax flexibility. The IRS allows a single-member LLC to choose how it wants to be taxed: as a sole proprietor, in which case the business taxes pass through to the owner, or as a corporation, in which case separate returns are filed. Multi-member LLCs can also choose how they want to be taxer: as a partnership, or as a corporation.
Paperwork. If you want to become a limited liability company, you’ll need to file paperwork in your state. Each state has different requirements and filing fees.
Business and personal finances must be kept separate. If you pay for business expenses out of your personal account, or vice versa, you can lose your liability protection.
Compared to corporations, both sole proprietorships and LLCs are easier to run. They require less paperwork and have fewer regulations to adhere to. Also, neither structure is especially attractive to investors like venture capitalists—many investors prefer corporations because of their strict regulations and oversight.
The question of sole proprietorship vs. LLC is a question of needs, so look at which business type best fits your situation. Having said that, all businesses benefit from liability protection, so it’s worth giving serious consideration to becoming an LLC. The legal protection you get could save you untold money and stress in the future.
If you’re still not sure which business structure is right for you, or want help setting it up, consider speaking to a business attorney in your state for insight and legal advice.